Important points
- Stock prices across the Morningstar Style Box Index are gradually approaching fair value.
- For nearly eight years, small-cap stocks have been undervalued, remaining the most affordable part of the market.
- Morningstar’s equity analysts have adjusted upward their price targets for important large-cap growth stocks, contributing to lower relative valuations.
The long-standing valuation gap among different stocks has decreased, resulting in a market with fewer extreme values.
As of early 2025, large-cap growth stocks were about 13% overvalued but have since shifted to roughly 4% undervalued. Meanwhile, mid-cap growth stocks have transitioned from 10% overvalued to fair valuation. Interestingly, small-cap value stocks improved from 19% undervalued to 10% undervalued, and mid-cap value stocks moved from 10% undervalued to around 5% undervalued.
The complete set of ratings for various style boxes is available at the end of this article.
What is driving the convergence to fair value?
Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth, attributes the movement toward fair value to several elements. Notably, the rebound in small-cap stocks has followed the sluggishness observed in the first ten months of 2025. The Morningstar U.S. Small Cap Index has surged 8.0% since November 1, significantly outperforming the overall market’s 2.4% gain.
This recovery is bolstered by lower interest rates, allowing small businesses—most of which have variable-rate debt—to benefit more swiftly. Additionally, possible regulatory leniency regarding mergers and acquisitions by the current administration is leading investors to look more favorably at small-cap stocks.
On the other hand, large-cap stock performance has stagnated recently. The Morningstar U.S. Large Cap Index has shown declines from tech giants. Concerns about whether AI companies will fulfill their ambitious promises have contributed to this downturn, with the likes of Nvidia down 5.4%, Apple down 5.1%, Microsoft down 6.8%, and Broadcom down 9.7%.
Fair value estimates raised for some large-cap growth stocks
Pappalardo indicates that Morningstar’s equity analysts are beginning to elevate their price targets for significant large-cap growth stocks. He notes, “Recent developments and persistent product demand have altered the valuation model’s inputs.” As large growth companies’ fair values rise, their price-to-fair value ratios decrease proportionately. In the last three months, Broadcom’s fair value estimate jumped 32%, while Apple and Alphabet experienced 14% and 13% increases, respectively.
This trend points to a broader rebalancing in the market. Notably, as the disparity between overvalued and undervalued segments lessens, both categories are trending towards fair value. This suggests that most overvalued stocks are becoming cheaper while undervalued stocks are gaining value, a natural market response that can help mitigate bubbles and extreme valuations.
Small-cap stocks remain the most undervalued style box segment
Even as they inch closer to fair value, small-cap stocks still rank as the most undervalued segment in the style box, currently trading at a 10% discount. They’ve largely remained undervalued over the past eight years, only briefly touching on overvalued levels back in February 2021 before dipping again, hitting a low of 35% undervalued in September 2022.
For the past decade, returns from small-cap stocks have often lagged behind the broader market, trailing in seven of those years. However, Pappalardo suggests that this reflects a historical bull market in large-cap growth, rather than a shortfall of small-cap value.
When addressing why small-cap value stocks aren’t consistently meeting targets, Pappalardo identifies several key factors:
- Small values are inherently further from large growth, making them more disconnected as the latter pushes the market upward.
- Tech stocks, which have been primary bullish drivers, make up a comparatively small portion of the small-cap value index, usually around 4% to 8% over the last decade, against 15% to 35% in the overall U.S. market.
- If a small-cap stock underperforms and its value declines, it might be shifted into the value category more quickly than fair value assessments can adapt.
Be careful with pure price and revenue judgments
Pappalardo points out that while the price-to-fair value ratio is a helpful tool for comparing market segments, it’s not the sole indicator. “It requires some subjective insight from analysts to determine fair value components,” he notes. A more objective metric might be fundamental valuations, like the price-to-earnings ratio.
He elaborates, “Viewed this way, the divide between large-cap and small-cap stocks appears to be expanding. Small-cap stocks concluded 2025 with a P/E ratio of about 0.65 relative to large-cap indexes, the narrowest in 25 years—whereas the historical average sits closer to 1. There was a time from 2003 to 2018 when small-cap stocks were frequently valued higher than their large-cap counterparts, with peaks around 1.22.”
