While updating the portfolio performance figures today I realized that I did not report the sale of DEXO from the Premium portfolio, as I typically do for my readers. So here it is DEXO Sale On Oct 25, I sold out of the remaining 50% of the DEXO I still owned and recommended the members… [Read More]
Small Cap Value Stocks Outperform Large Caps and Other Asset Classes
Over a long investment horizon, small cap stocks deliver superb investment returns, better than any other asset class and many percentage points better than the market as a whole. Once we have reviewed the evidence, you can read the articles and screens we publish regularly that aim to find new small cap stock ideas for our readers. We can also send you all these ideas and screens in your email as they are published so you never miss them.
There is a body of research that shows that over a long investment horizon, small cap stocks have outperformed their large cap brethren. At the same time, value stocks outperform growth. In one study, Ibbotson Associates studied the annual performance of stocks classified by size (large, mid, small and micro) as well as by style (growth and value) between the periods 1969 and 2002. They found that the small cap value and micro cap value stocks far outperform all other asset classes. At the same time, small cap growth and micro cap growth are the worse performing asset class.
|Mean (%)||Mean (%)||Deviation (%)||Ratio|
See also: share book value
Another interesting insight from this table is that for every capitalization class, the value stocks have smaller standard deviation from the mean, which implies that value stocks carry less risk than their growth counterparts with similar sized companies.
Looking at the Sharpe Ratio, which measures risk adjusted returns, it is striking to see the difference between the highest performing asset class (Small-Cap Value) and the lowest performing asset class (Micro-Cap Growth). Small Cap Value stocks have historically returned highest returns for any level of risk you are willing to take in your investments.
Another study that measured asset class performance between 1927 and 2005 confirms a similar pattern.
|Total Stock Market||
Still, investors continue to focus on finding the next explosive growth story. For every Microsoft or Cisco Systems, there are literally hundreds of growth stocks that fizzle out. Odds of finding that one stock that will secure your retirement is slim, perhaps even less than the odds most casinos give you.
Why do Small Cap Value Stocks Perform So Much Better?
If you follow the Efficient Market Hypotheses, you would assume that if the markets are efficient, than any source of out-performance will be quickly eliminated as investors discover these stocks and pile on. However, there are very practical reasons why this does not happen in the real world.
- Small Cap Value stocks are generally very boring companies that no one has heard of. These are unglamorous companies, unlikely to garner much oohs and ahhs around the dinner table
- Investors over react to growth prospects and bid up the shares high. That is why growth stocks are expensive and provide smaller returns. On the flip side, investors over react and force the smaller value stocks down at the slightest whiff of bad news or general discomfort.
- There is insufficient coverage of these stocks on the Wall Street due to smaller size and lack of liquidity. As a result, they escape the attention of most institutional and retail investors who depend on stock brokers or sell side analyst’s recommendations
- Most institutions and funds are not allowed to own small cap and micro cap stocks and if they do come into possession of any such stock, perhaps due to a spin off, they are forced to sell off their position
- Many small cap stocks fall into special situations and become difficult to analyze using traditional fundamental analysis processes
Due to these reasons, there is little investor interest in small cap stocks. But enterprising value investors know that small caps offer the best places to find true value stocks that will on average comfortably beat the market over the long term.
Finding Promising Small Cap Value Stocks
With the coverage of these stocks so scant, a value investor literally needs to comb through the entire universe of small cap stocks to find promising candidates. With each of these stocks, the investor needs to go through the public filings and annual reports to understand the company, analyze the business and its financials and figure out a reasonable valuation of the company. Once this research in small cap stocks is complete, it is a matter of purchasing those stocks that offer good value and patiently wait for the market to understand its folly and discover these stocks. This is time and labor intensive work for most investors and a typical investor is not willing to patiently sit on his or her shares for a long time if immediate returns are not visible. However, patience is required if you want the rewards. That is why we help investors find great value stocks to buy through our Premium service.
View articles in other categories: Dividend Stocks, Large Cap Stocks, Mid Cap Stocks, Macro-economic, Value Investing Tips, Investing Questions, Business, Personal Finance, Investment Guide, Investment Definitions
There are actually two sales to report. Tuesday Morning (TUES) was purchased on Mar 9, 2012 at an average cost of $3.64/share. Last week, on Sep 9, 2012, the entire position was liquidated at $6.26/share for a gain of 71.18% Another partial sale was made on Aug 21, 2012 on a stock that I still… [Read More]
Small cap stocks generally have a liquidity problem.
This is one of the reasons why most investors stay away from small cap stocks. This is also one of the reasons why good undervalued stocks are easier to find in this asset class.
The market for highly liquid stocks is also normally highly efficient. The price you pay for the convenience of having your transaction execute in seconds (instead of hours or sometimes days) is returns that are at best average.
In my 18 years of investing in small cap value, I have found that lack of liquidity is hardly ever an issue. Part of it is just practicing good investing habits. The other part is understanding precisely what we are doing when investing in small cap value.
Last week I sold off Homeowners Choice (HCII), a Florida based Property insurer. The stock was initially recommended to the Premium members in March of this year, and I purchased the stock for the Value Stock Guide portfolio on Mar 02, 2012 at an average cost of $11.18/share including commissions. The stock was sold at… [Read More]
The saga of Network Engines (NEI) comes to an end with the agreement today with Unicom Systems to acquire the company for $63.2 m in an all cash deal and take it private. The price offered at $1.45/share is 85.8% above the closing price of NEI yesterday at $0.78/share. I recommended and purchased Network Engines… [Read More]
Tii Network Technologies (TIII) is a small communications company that accepted an offer of $33 m from Kelta Inc on Monday. This offer values company’s shares at $2.15/share which is a 48% premium to the stock’s closing price on Friday. Based on the assets, I feel that this acquisition is a good price for Kelta… [Read More]
I initially purchased UVV (Universal Corp) in the Value Stock Guide portfolio on Oct 13, 2011 at an average cost of $41.03/share and sold out of the entire position on May 10, 2012 at $45.72/share. Including commissions, the average capital gains amounted to 10.94%. UVV has also paid $0.98/share in dividends in the interim. Including… [Read More]
Westell Technologies stock (WSTL) can be bought for close to the cash on its books. With a profitable business, this net-net stock can be a great undervalued investment for patient investor. The catalyst to move this stock forward will be the management’s strategy to put its cash to use to grow its OSP segment either organically or through acquisitions.
VSE Corp (VSEC) provides engineering and consulting services to the Federal government in the USA, primarily to the Department of Defense and the US Postal Service. These include maintenance of defense equipment, naval ships, logistics support, field engineering, IT support and consulting, and foreign military sales support. The company was founded in 1959 and is… [Read More]
ZIXI stock has shown up on many of my screens before and every time it did not make it to the Value Stock Guide Watch List. At a first glance, the stock indeed looks undervalued on many levels but a deeper look reveals a different picture. I want to outline my reasons on why I… [Read More]