By weighting firms by their profits, WisdomTree creates a a list of stocks that are cheaper than those in the S&P 400 index. By Nellie S. Huang, Senior Associate Editor February 26, 2012 If conventional wisdom holds true, stocks of smaller companies should outpace large-company stocks as this nascent economic recovery takes hold. The year is still young, but in the first month of 2012, Standard & Poor’s MidCap 400 index rose 6.6%, while the big-company-oriented S&P 500-stock index notched a 4.5% gain. SEE ALSO: 6 Great ETF PortfoliosEnter WisdomTree MidCap Earnings (EZM), an exchange-traded fund that tracks a proprietary index. Rather than take the standard approach of weighting stocks by market value, MidCap Earnings’ underlying index weights companies by the amount of profit they generate—specifically, earnings from operations over the previous four quarters. The index and the ETF, which typically holds companies with market values of $2 billion to $10 billion, are rebalanced every December. WisdomTree’s culling results in a list of stocks that are cheaper than those in the S&P 400 index. In early February, the average price-earnings ratio of the WisdomTree ETF (based on estimated earnings) was 12, compared with 16 for the S&P index, says WisdomTree’s Jeremy Schwartz. The ETF also holds more in out-of-favor technology and consumer cyclical stocks than the S&P 400, he adds. So far, so good. From its launch in February 2007 through February 2, the ETF returned an annualized 4.8%. That beat the S&P 400 index by an average of 1.3 percentage points a year.