Small and ValuableSubmitted by Concorde Financial Resources LLC on March 7th, 2018
“You can’t time the market.” “Don’t chase performance.” “Nobody can predict the future.”
All of these quotes are common sayings that you may hear from your financial advisor from time to time and they’re all quite true, even if they are extremely cliché. But another axiom that eventually comes out is:
“Value beats growth over time” and “small caps beat large caps over time”.
These statements are also statistically true but perhaps they require a bit more unpacking than the previous statements, especially after being false for the past decade…
Value stocks, those that trade at a cheaper price multiple relative to its fundamentals, usually pay dividends and have likely been profitable for a long time. Think General Electric. While growth stocks are those that are growing at a quicker pace and are likely more expensive based on its price multiple to its fundamentals. Think of Facebook or Amazon these days (or maybe Lowe’s in the 1990’s). These companies are so busy growing, they need all of their available capital to expand, nevermind paying a dividend to investors. Small cap stocks are companies that are simply those valued at less than $2B and large cap companies are typically valued above $10B. Small caps are typically a bit more volatile as well (Smaller companies have less of a track record and go out of business sometimes). So with the definitions behind us, why do small caps and value stocks outperform over time?
Well they don’t always. In fact, large cap stocks and growth stocks have been outperforming for the past 9 years. One likely reason growth stocks have done better recently has been the historically low interest rate environment. When cheap capital is readily available, growth stocks typically benefit. Likewise, when money is more expensive during higher interest rate periods, those established companies (value companies) with solid balance sheets can continue business as usual. But over the past 80 years, value stocks have outperformed growth stocks in all but 12 rolling 10 year periods. That’s a vast majority. Small cap stocks have a similar record. Though more volatile than large cap stocks, small caps tend to do better in rising rate environments as well. Many believe this is because smaller companies are more nimble than larger ones. Larger companies are glacial like in their responsiveness to changing environments (tax code changes, interest rate changes, etc.) but smaller companies can adjust more rapidly. Logically, that makes sense. The proof is in the numbers. From 1927-2016 Value stocks have averaged 12.92% annual returns and Growth stocks have done 9.33% Similarly, from 1928-2016, Small caps have averaged 12.15% annually vs 9.75% for Large caps. That’s significant.
Of course it’s wise to be diversified, owning both large, mid and small cap stocks. And of course you should own value and growth stocks too. But perhaps for those long-term investors, we should give a little more consideration to those value and small cap companies. 80 years of history has proven those two categories to do better even if they have underperformed recently in this low interest rate environment. And since we’re approaching nearly 10 years of large caps and growth stocks outperforming, aren’t we overdue for a correction to value and small caps? History suggests we are…
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