The WisdomTree Small Cap Earnings Exchange-Traded Fund, or ETF, (NYSEARCA: EES) takes a different sort of approach to investing in small-cap stocks. This ETF tracks an index of small-cap equities in the United States weighted by company earnings from its core business operation. The underlying index, the WisdomTree Small Cap Earnings Index, is a subindex of the WisdomTree Earnings Index. The theory behind choosing to weight holdings according to earnings rather than according to market capitalization is based on the fact it is earnings, not market capitalization, that provide investment returns. The fund invests in several hundred small- and micro-cap stocks, with no single firm accounting for much more than 1% of the fund’s total holdings. Among its holdings are Oasis Petroleum Inc., the St. Joe Company, PDL BioPharma Inc., Delek U.S. Holdings and The Ryland Group Inc.
Small-cap stocks are appealing to investors primarily because of their above-average growth potential. It is simply much more probable for the share price of a $10 stock, as opposed to a $500 stock, to double or triple in value. However, with higher upside potential usually comes a higher level of downside risk.
Small-cap stocks are defined by market capitalization. Stocks with a market cap between $250 million and $2 billion qualify as small-cap stocks. Stocks with a market cap of less than $250 million may also be referred to as small-cap stocks but are more precisely identified as micro-cap stocks.
Smaller firms are often under-recognized and consequently undervalued, making them potentially appealing to value investors and growth investors.
Small-cap companies, because of their relatively lower level of capital as compared to larger firms and because they do not typically have the same level of access to financing as larger firms, are considered inherently more risky than large-cap companies. They are generally more vulnerable to market or economic downturns. Small-cap stocks also tend to experience greater volatility.
Since small-cap companies generally have a less well-established history and market performance, they can be more difficult for investors to evaluate. There is usually much less readily available material written by market analysts on small-cap companies. Most analysts, unless they have a particular specialty in small-cap stocks, tend to pay more attention to large-cap stocks.
Because individual small-cap stock analysis can be challenging, many investors consider using an ETF with a small-cap focus to obtain exposure to a selection of small-cap stocks.
This WisdomTree ETF, launched in 2007, has over $400 million in assets under management, or AUM. With an average daily trading volume of approximately 10,000 shares, it is not as liquid as many other funds but still has adequate liquidity for long-term investors. The fund's expense ratio is 0.38%, and it offers a dividend yield of 1.16%.
The fund's five-year annualized return is 15.5%. The weighted average market cap of the stocks in the fund's portfolio is $1.1 billion. The weighted average price-to-book ratio, or P/B ratio, is 1.77. The fund's small- and micro-cap holdings are well-diversified across more than 10 market sectors, with the largest concentration of 25% in financials and 17% in consumer cyclicals and another 17% of holdings in industrial stocks.
Suitability and Recommendations
The WisdomTree Small Cap Earnings Fund is ideal for investors seeking to obtain exposure to a broad selection of small-cap and micro-cap stocks from major market sectors, and who agree with the fund's stance of weighting portfolio holdings based on earnings rather than on market capitalization.
Additionally, the fund is suitable for growth, or speculative, investors who are comfortable with relatively high levels of risk. It is not appropriate for conservative, risk-averse investors. The fund's relatively low P/B ratio of 1.77 may also make it attractive to value investors. Its low dividend yield of just over 1% does not make it a prime selection for income-focused investors.
An average beta of 1.05 reveals the fund is subject to slightly above-average volatility; however, it should be noted the fund's down beta is 0.99, indicating most of the fund's excess volatility is to the upside.