Nov. 13 (Bloomberg) -- Valuations for the smallest U.S. companies have climbed to the highest level in 13 years, raising concern they may start trailing returns from bigger stocks.

The Standard & Poor’s SmallCap 600 Index trades for 34 times its companies’ earnings from the past year, or 57 percent more than the Standard & Poor’s 500 Index of the largest U.S. stocks. Small-cap equities have gained 71 percent since markets bottomed in March, compared with 62 percent for the S&P 500, according to data compiled by Bloomberg.

The last time small caps commanded as big a premium was in May 1996, when they went on to trail the S&P 500 by an average of 23 percentage points annually through March 1999. The current valuation disparity widened during the eight-month equity rally in part because profits for smaller companies fell at a faster rate, data compiled by Bloomberg show.

“Our view on small caps has been very cautious,” said Dan Farley, head of a group overseeing U.S. asset allocation at State Street Global Advisors, which manages $1.7 trillion in Boston. “In this particular environment, it never got to the point where it was a very compelling small-cap buy.”

The valuation for the small-cap measure has exceeded the S&P 500’s since 2002, when the bear market following the so- called Internet bubble ended. The premium lasted during the worst equity market losses since the Great Depression in 2008 and 2009, when annual earnings for S&P SmallCap 600 companies fell 54 percent from their peak. Profits declined 45 percent in the S&P 500.

Slowing Growth

Profit growth will also be slower for small companies in the fourth quarter, according to the average analyst forecasts in a Bloomberg survey. Earnings for companies in the small-cap index are projected to increase 38 percent during the last three months of 2009, about half as fast as S&P 500 income.

Companies in the S&P SmallCap 600, which have a median market value of $562.8 million, are also more expensive based on estimated earnings, data compiled by Bloomberg show. The small- cap index trades for 17 times projected 2010 profit, a 20 percent premium to the S&P 500, whose companies are 15 times bigger on average. The 29 percent valuation gap in July was the highest in at least three years, Bloomberg data show.

Twenty-seven percent of S&P SmallCap 600 companies trade for at least 20 times analysts’ profit estimates for next year, compared with 18 percent of the S&P 500, according to data compiled by Bloomberg.

Steaks, Rubber Shoes

OfficeMax Inc., a business-supplies retailer based in Naperville, Illinois, is valued at 26 times projected 2010 earnings, Bloomberg data show. Indianapolis-based restaurant chain Steak n Shake Co. trades at 40 times next year’s income, while rubber-shoe manufacturer Crocs Inc. has a multiple of 28. Houston-based Landry’s Restaurants Inc., owner of the Rainforest Cafe, trades at 108.

“We don’t have a big weighting for small caps,” said E. William Stone, who oversees $104 billion as chief investment strategist at PNC Wealth Management in Philadelphia. “People typically argue that small caps outperform at the beginning of a recovery, but our fear was that they were too expensive.”

Small-cap stocks usually beat the S&P 500 during the first 240 trading days of a bull market, according to data from Westport, Connecticut-based Birinyi Associates Inc. That would place the peak of the outperformance in February 2010.

“It’s just the first leg of where these stocks are going to go,” said Mike Balkin, a fund manager at William Blair & Co., which oversees $41 billion in Chicago. “Small-cap stocks are the best asset class.”

Outperforming Already

Balkin runs the William Blair Small Cap Growth Fund, which has returned 62 percent in 2009, beating 99 percent of its peers, Bloomberg data show.

Larger stocks may have already begun to overtake small caps, according to data compiled by Bloomberg. Since the S&P SmallCap 600’s P/E peaked at a 64 percent premium to the S&P 500’s on Oct. 9, the small-stock measure has retreated 4 percent, compared with a 2.1 percent gain in the S&P 500.

Strategists such as Dan Wantrobski at Janney Montgomery Scott LLC say smaller companies will falter relative to large caps because they get less revenue from faster-growing countries. Companies in the small-cap index generated 34 percent of sales outside the U.S. in 2008, compared with 48 percent for the S&P 500, according to data compiled by New York-based S&P.

Dollar’s Slump

This year’s 7.4 percent drop in the U.S. Dollar Index, a six-currency gauge of the greenback’s strength, has made American goods more competitive overseas and boosts revenue when the foreign currencies are brought back to the U.S.

Countries from China to Brazil will grow faster than the U.S. next year, according to the median economist estimates compiled by Bloomberg. China, the most-populous nation, is projected to expand at a 9.5 percent pace. Brazil, Latin America’s biggest economy, will increase gross domestic product by 3.8 percent, compared with 2.5 percent in the U.S., the estimates show.

“The weaker dollar theme is what’s pushing money managers into the high-quality, multinational large-cap space,” said Wantrobski, director of technical research at Janney Montgomery Scott in Philadelphia. “You’re seeing a gravitation away from small-cap, mid-cap companies, and people are going for best-of- breed stocks.”

To contact the reporters on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net; Sapna Maheshwari in New York at smaheshwar11@bloomberg.net.

Last Updated: November 13, 2009 16:40 EST