There is perhaps a case to be made that the answer might be "never". At least, not a reversion back to the old trend.

The observation underlying that is that small companies are very much worse quality than they used to be. Decent and half-decent ones get acquired, and only the dregs stay (or go) public.

Consider:

The average level of profitability among small caps is much lower than it used to be. Almost a third of R2000 companies are unprofitable, compared to 5% twenty years ago. In the 1990s, small caps routinely delivered returns on invested capital in the teens. Today, the index ROIC is in the 3-4% range. Some of that is due to more early-stage health/biotech companies as a fraction of the set, but that's a minor effect.

The average level of debt is very much higher and tends to be at floating rates unlike the large cap cousins. Excluding the tech bubble years, average net debt to earnings used to be 2 times, now it's over 3 times.

Jim

Mechanical Investing FAQ

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