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For the Russell 2000 benchmark, leaving out the unprofitable companies means setting aside what for the past year has amounted to more than one third of the market value of the small-cap index, according to an analysis from Jefferies looking at earnings over the previous 12 months....
....Yet, other analysts say it’s misleading to present a valuation metric that omits such a substantial share of the Russell 2000. Investors who own the stocks in the index aren’t weeding out the hefty portion without earnings.
“You’re taking out like six, seven hundred companies from your calculation,” Steven DeSanctis, small- and midcap strategist at Jefferies. “If you took out all the Cs and Ds that I got in high school, I was a solid B-plus student.”
Metrics that include negative earnings show the Russell 2000 went from trading at 27 times its past 12 months of earnings at the end of March 2020 to trading at 238 times earnings one year later, according to data from index provider FTSE Russell. That multiple fell by nearly half over the following month, and as of July was down to about 70.
With loss-making companies removed, the Russell 2000’s price-to-earnings multiple was both lower and less volatile: about 14 in March 2020, up to nearly 25 in March 2021 and then down to 19 at the end of July.