No. of Recommendations: 20
Thanks for the post, Manlobbi, but I still have my doubts.
My concern is not so much that the small caps are unprofitable (though there is plenty of that out there), but more generally that on average they are not nearly as high quality businesses as small caps used to be, and of course not as profitable as large caps in general. They aren't as profitable as businesses in the sense that they don't have the same return on assets or equity, and they are more fragile in that they are running with higher gearing than they used to. They may or may not be a good class to be in at the moment in terms of forward price returns, and the outlook for the S&P 500 is not great so it may make an easy comp, but I don't think that the historical US small cap results are going to give us a reliable answer on that because things have changed. The biggest issue is the big increase in the share of aggregate value added going to the top 2-3 companies in almost every industry. The long tail is now that of a mouse, not that of a T-rex. I would not base any investment decisions foursquare on historical rates of growth among the tiddlers, nor on mean reversion between indexes.
You mention faster growth, but which metrics are you looking at? And is that the historical rate of growth of the index including past eras when the quality of firm was better? i.e., is there any reason to think that *today's* small caps have growth rates on average higher than those of larger firms?
I haven't done that study as I don't have the data here myself, but I'm dubious anyway : ) Dubious that they are [now, especially] a place to find higher typical growth in metrics correlating with value. Though it's not the same thing because it misses the other S&P600 index criteria, I note that the median 5-year sales growth among those stocks currently in the S&P600's market cap range is 2.5%/year lower (not higher) than the median among S&P 500 members. EPS growth 2.0%/year slower. Ten year rate gaps in the same direction but a tad smaller gap.
Times are very tough for small firms, many have run up too much debt, and many of the minority that were prospering anyway have been acquired. The average attractiveness drops rapidly if the upside outliers are removed.
Jim
