P/E is typically lower for small stocks, though there are many exceptions. What explains that?
On March 1, 2024, the P/E for the S&P 600 small stock index was14.7 while that for the S&P 500 (weighted towards large stocks) was 21.2. Small stocks typically have higher growth prospects so, based on growth expectations, the P/E of 14.7 looks cheap. But buying growth in small firms could be quite risky so, with a discount for that risk, the lower P/E could be appropriate. As chapter 2 emphasizes, P/E is determined by expected earnings growth but also the risk to growth.
Buying small firms has typically yielded higher returns that large firms. This so-called small-firm return premium is sometimes seen as gravy, the yield to a trading strategy to earn abnormal returns (alpha). But higher returns go with higher risk, so the return premium could just be reward for taking on higher risk. Chapter 12 examines the small-firm return premium from this perspective.