Do Small Caps Outperform the Market?

[Zaxon]

I've run the math to see whether small caps actually outperform the market over a long period of time.

I find from 1972-2019, the CAGR (annualized returns) are:

• US Large Caps: 10.27%
• US Small Caps: 11.70%
• US Stock Market: 10.33%

So small caps do outperform the rest of the market, albeit they are more volatile. These returns include dividends reinvested.

 

[greggles]

Interesting that long term there's not much difference between small caps, large caps and the market generally.

It's probably why most people invest in ETFs these days. Why be a stock picker if you don't have to.

 

[Garpal Gumnut]

Interesting that long term there's not much difference between small caps, large caps and the market generally.

It's probably why most people invest in ETFs these days. Why be a stock picker if you don't have to.

Look at my post on LLC below.

gg

 

[aus_trader]

Over a long period of time, I think the result is as expected. Certainly true that small caps tend to be more volatile which can give a perception that they might outperform. From experience what I have seen is when the market is hot small caps can outrun the laggards but when the market is risk averse guess which ones get sold down or liquidated first... hence the volatility.

 

[qldfrog]

In the last recent bull asx100 easily beat asx300 which from memory has not reached its former high pre gst yet
There is a current move to relative safety with the big boys
People buy asx100 or even top ten as a bond replacement for safety in an uncertain world IMHO

 

[Junior]

I've run the math to see whether small caps actually outperform the market over a long period of time.

I find from 1972-2019, the CAGR (annualized returns) are:

• US Large Caps: 10.27%
• US Small Caps: 11.70%
• US Stock Market: 10.33%

So small caps do outperform the rest of the market, albeit they are more volatile. These returns include dividends reinvested.

I would be interested to see the results from 1972 to say, 2006. In the past 10 years we've seen the relentless growth of a handful of giants. I.e. Amazon, Google, Facebook, Apple. I wonder if that is skewing the results a little.

 

[basilio]

I wonder..

I have an overriding problem with the use of the types of analysis that Zaxon is using. As far as I can see the figures refer to surviving stocks in any of the categories. Essentially stocks that fail fall out of the basket and are replaced with new shares. But if you had invested in the failed shares you lost your money.

I would think that small cap shares would have a higher proportion of failed shares than larger caps. On the other side of the ledger the potential of some small caps to do very well would be higher than large caps becasue of the leverage. So of a relatively few small caps did very well it would boost the overall performance of the group.

 

[systematic]

I wonder..

I have an overriding problem with the use of the types of analysis that Zaxon is using. As far as I can see the figures refer to surviving stocks in any of the categories. Essentially stocks that fail fall out of the basket and are replaced with new shares. But if you had invested in the failed shares you lost your money.

I would think that small cap shares would have a higher proportion of failed shares than larger caps. On the other side of the ledger the potential of some small caps to do very well would be higher than large caps becasue of the leverage. So of a relatively few small caps did very well it would boost the overall performance of the group.

Great thinking, basilio. It's often called 'survivorship bias'.
But you can account for this by ensuring your data includes delisted stocks etc. i.e. that you're looking at the data 'as it would have been' at that point in time.

 

[basilio]

Great thinking, basilio. It's often called 'survivorship bias'.
But you can account for this by ensuring your data includes delisted stocks etc. i.e. that you're looking at the data 'as it would have been' at that point in time.

Fair enough. But is that how the figures that Zaxon (and other orgs) sprout calculated ? I can't see how the losses and failures are included in an analysis which calculates the value of the either the top shares or just the ones still alive.

There is another element worth considering in these calculations. Most small caps start with, say 100Million shares at, say, 10c each and thus having a market value of $10m.

Over the next few years there will be numerous capital raisings to keep chasing development and pay the directors. So in 5 years there could easily be 1B shares on issue currently at say 3cents.

So the market value of the company is now $30M - which looks good and boosts the index - but the $10k of shares you held at the start is now worth $3,000.

 

[aus_trader]

Fair enough. But is that how the figures that Zaxon (and other orgs) sprout calculated ? I can't see how the losses and failures are included in an analysis which calculates the value of the either the top shares or just the ones still alive.

There is another element worth considering in these calculations. Most small caps start with, say 100Million shares at, say, 10c each and thus having a market value of $10m.

Over the next few years there will be numerous capital raisings to keep chasing development and pay the directors. So in 5 years there could easily be 1B shares on issue currently at say 3cents.

So the market value of the company is now $30M - which looks good and boosts the index - but the $10k of shares you held at the start is now worth $3,000.

As systematic said, real food for thoughts basilio. In terms of bankruptcies/administrations/liquidations, more often its the small caps go into the dreaded 'Trading Halts' and never come out on the market again. Recent examples would be "ARI" & "GCY". It also happens to a few large caps like the infamous "Babcock & Brown" and "ABC Learning Centres" but it's rare hence these names are memorable long after since they usually create huge news headlines.

Especially in the mining spec punting days post GFC, I've had my hard-earned money flushed down the toilet with a few penny stocks that got de-listed netting me...

…


wait for it...


… a big FAT zero $$.

There has not been any recent casualties in my portfolios (touch wood), as you can see since I journal all my stocks held for all ASF members to see.

 

[basilio]

Yeah Aus Trader the small caps and spec shares can look very enticing and in the short term one can make some serious money. I was successful with a few of my "investments" over the years.

And then it all went to xxxxx. Frankly my view now is that the overwhelming majority of these shares are vehicles to enrich a pool of directors and stock advisors while encouraging some short term speculation which, if one is quick and canny, can net some gains. I once held EDE and now just watch as the Directors squeeze the company and shareholders until the pips squeak.

So overall I think small caps are a roulette table with about 10 zeros on the wheel.

 

[Zaxon]

I would be interested to see the results from 1972 to say, 2006.

Jan 1972 - Dec 2006
US Stock Market: 11.07%
US Large Cap: 11.03%
US Small Cap: 12.92%

 

[Zaxon]

Fair enough. But is that how the figures that Zaxon (and other orgs) sprout calculated ?

I believe it's calculated on the indices. By definition, stocks that perform poorly are removed, so it's based on the index constituents at each point in time. Also, the small caps index doesn't include microcaps.

 

[basilio]

I believe it's calculated on the indices. By definition, stocks that perform poorly are removed, so it's based on the index constituents at each point in time. Also, the small caps index doesn't include microcaps.

Ok so it is just counting the winners. Whenever a zero comes up on the wheel the punters take the loss.

 

[Zaxon]

In terms of bankruptcies/administrations/liquidations, more often its the small caps go into the dreaded 'Trading Halts' and never come out on the market again.

This is true. Big caps are safer. But big caps get delisted far more regularly than most people realize, with 40% of them gone in the last 12 years.

 

[sptrawler]

Fair enough. But is that how the figures that Zaxon (and other orgs) sprout calculated ? I can't see how the losses and failures are included in an analysis which calculates the value of the either the top shares or just the ones still alive.

There is another element worth considering in these calculations. Most small caps start with, say 100Million shares at, say, 10c each and thus having a market value of $10m.

Over the next few years there will be numerous capital raisings to keep chasing development and pay the directors. So in 5 years there could easily be 1B shares on issue currently at say 3cents.

So the market value of the company is now $30M - which looks good and boosts the index - but the $10k of shares you held at the start is now worth $3,000.

Then they have the dreaded share consolidation, just before the death throes, so initially the price lifts then slides back to where it was before the consolidation.

 

[aus_trader]

This is true. Big caps are safer. But big caps get delisted far more regularly than most people realize, with 40% of them gone in the last 12 years.

View attachment 96527

Oh I see. It's actually higher than I thought for Big/Mid Cap failures. So there needs to be caution even in the top end of town. Some of the big names that are actually gone recently surprised me...

Blue Sky Alternative Investments (BLA)
RCR Tomlinson (RCR)
Axsesstoday Ltd (AXL)
Big Un Limited (BIG) - was a trader's favourite

Then there are many others that have had big share price declines but still in existence such as...

Retail Food Group Limited (RFG)
Slater & Gordon Limited (SGH) - possibly an example of what sptrawler mentioned in the above post with regards to share consolidations, which SGH did in Dec-2017.
Reject Shop Ltd (TRS)

 

[Zaxon]

Oh I see. It's actually higher than I thought for Big/Mid Cap failures. So there needs to be caution even in the top end of town.

Yup for sure. I think it comes down to diversification. If you own hundreds of stocks - like an index fund - then you'll never outperform the market. So outperformance comes from concentration. But if you're overly concentrated, you'll have fears like those expressed by basilio who thinks that all small caps are dangerous.

I think the trick to investing is to pick enough shares where you feel comfortable that if one blows up on you and another drops by 50%, that it's not going to cause too big a dent in your wealth. What that number is, comes down to the temperment of the individual investor. And for some, that may mean holding index funds.

Some of the big names that are actually gone recently surprised me...

Blue Sky Alternative Investments (BLA), RCR Tomlinson (RCR), Axsesstoday Ltd (AXL), Big Un Limited (BIG)

Then there are many others that have had big share price declines but still in existence such as...

Retail Food Group Limited (RFG), Slater & Gordon Limited (SGH), Reject Shop Ltd (TRS)

That's an excellent list there! And we could add AMP. Big names fall from grace often enough to not blindly trust them.

 

[basilio]

But if you're overly concentrated, you'll have fears like those expressed by basilio who thinks that all small caps are dangerous.

Not quite what I meant Zaxon. What I was saying in my comments was that the analysis which seemed to show that small caps had a better return than other sectors was skewed by the relatively high failure rates which buried the losses.

But my overall feeling is that there is a large element of speculation and pure BS in the small mining specs and many (not all...) small cap companies. I could continue to spell this out but I suggest most people on ASF can recognize the hype and push marketing around many of the mining stocks . I mean promoters just change the name of a stock to the new flavour of the month to get buyers sucked in. Whether it's graphite, lithium, gold, IT the main game, in my view, is not building a company but extracting as much cash for the promoters/directors as possible.
Investor beware..

 

[aus_trader]

I mean promoters just change the name of a stock to the new flavour of the month to get buyers sucked in.

I can vouch for that. When I was first searching for ways to play the Bitcoin boom, I came across so many spec symbols that had been renamed to include some sort of 'Block Chain / Digital Coin' flavour added. Most of them were previous mining firms that were so overlooked and ignored by the market that they couldn't get their share price to move up even if you put a rocket under them. As soon as they got renamed or changed business direction to go into Digital currency or Bitcoin mining or something... BANG the share prices magically took off at least for a short while.

I was lucky to pick up some Digitalx Ltd (DCC) shares after doing due diligence on so many of them, because along with Bitcoin rallying up and up towards the $20,000 mark (named as the biggest bubble in all of history even bigger than the infamous Tulip bubble), DCC also multiplied many times from my initial buy price and was sold for a nice profit.