Small Company Stocks
Will They Ever Again Outperform the
Large Caps? |
| November
9, 1998 |
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| The chart below illustrates the average
annual return realized by large and small company stocks over the rolling 10 year holding
periods beginning in 1935 and ending on December 31, 1997. Although the 10-year performance of small caps seems to have lagged the large
caps since 1988, there were still years in which they performed considerably better, thus
adding a diversification benefit to your portfolio. The most recent period of
outperformance came in the years 1991 through 1993, when small cap returns were 51.61%
(vs. 30.55%), 26.03% (vs. 7.67%), and 19.86% (vs. 9.99%). |
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| On a related note, a recent study by two
Harvard professors suggests that the small cap underperformance in recent years may be due
to a structural change in the market. Specifically, the proportion of individual
investors holding stocks has fallen in recent decades from 90% to 10%, with institutional
investors now holding 90% of all individual issues. And, according to the authors,
institutions prefer large cap stocks. The
price-to-book (P/B) ratio, a measure of the valuation that the market assigns to a
company's assets, had a value of 1 for both large and small company stocks in 1980.
Since then it has risen to 2 for small caps and 3 for large cap stocks, indicating
that valuations of larger companies' assets have risen 50% more than those for small
companies. Since small companies have seen more book value growth than than large
companies, small caps would still have outperformed large caps in the absence of the 50%
"valuation premium" (did that make sense?). In any case, the researchers
conclude by suggesting that this extreme undervaluation of small caps probably holds the
potential for renewed small cap overperformance in the years ahead. |
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