Small cap, value oriented stocks “trounced” large cap stocks by a ratio of over 30 to 1.
Over the long run, small cap, value oriented stocks “trounced” large cap stocks by a ratio of over 30 to 1. That is, a dollar invested in the Standard & Poor’s 500 Index at the end of June 1927 would have accumulated to $2,636 by July 31, 2005 (capital gains + dividends reinvested).
However, that same dollar invested in 1927 in smaller publicly traded companies, those which are considered value-oriented with lower price/book value ratios, would have grown to an astounding $85,811 by July 31. 2005.
Moreover, for shorter time horizons (than the entire 83 year period under study), the small value strategy outperformed the S&P500:
- 100% of all 20-year time periods since July 1927
- 84% of all 10-year time periods since July 1927
- 69% of all 5-year time periods since July 1927
Caveat: the volatility of annual returns for small value stock portfolios has been 50% greater than the volatility of returns for the S&P500 Index. Thus for some time periods, particularly those of shorter duration, the small value portfolio can under-perform large stocks.
Technical/Statistical support of conclusions
Monthly returns were obtained from Professor Ken French’s website at the Amos Tuck Graduate School of Business at Dartmouth. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/
Professor French took a large universe of common stocks and divided them into large vs. small market capitalization (market price times #common shares outstanding) based on the median capitalization. He then further divided each of these sub-universes in thirds using book value/market value. This resulted in 2 x 3 = 6 portfolios. Each June, Professor French would recalibrate the market capitalization size and revise his portfolio groupings by size. Book value is based on the latest fiscal year data divided by the market value at the end of December of the previous year.
The “small value portfolio would be the small capitalization stocks with the highest third of book/market ratios. Book/market value is a common measure used by academic researchers and investment professionals to distinguish between value-oriented and growth-oriented stocks. (Price/earnings ratios and dividend yield are also sometime used to differentiate value vs. growth.)
The S&P index returns were gathered separately, but they would be closely proxied by the large-capitalization stocks with the middle-third of the book/market ratio in Ken French’s universe.
Professor French’s monthly returns include capital gains plus dividends. Professor French also provides annual returns for 1927-2004.
I used the monthly returns and linked them together geometrically to form wealth indexes, starting at $1.00 (as of June 30, 1927.)
Volatility statistics (standard deviations) can be measured from monthly or annual return data. I looked at the annual statistics and found:
French’s Small value portfolio standard deviation = 31.8%
French’s large cap portfolio standard deviation = 21.5%
S&P 500 Portfolio standard deviation = 20.4%
The wealth indexes are cumulative since 1927, but rolling period returns, e.g., 10-year rolling periods, can be easily constructed. [The first period would run July 1927 through June 1936; the second period would run August 1927 – July 1936, etc.].
I thought it would be interesting to see how often a small value portfolio would outperform large stocks over 5-year periods or 10 year period or 20 year periods. Looking back historically…
for 20-year periods (there were 710 of them), small value always outperformed the S&P. In fact in the very worst case, small value grew $1 to $325 over a 20-year period, whereas in the worst case, the S&P grew to $2.12.
for 10 year periods (there were 810 of those), small value outperformed the S&P 83.7% of the time. In the worst case, the small value strategy shrunk a $1 investment to $0.49 over 10 years; while the S&P’s worst case was to shrink $1 to $0.60. Those really bad outcomes happened in the 1930s. Since 1950, the worst case for small value is that $1 grows to $1.85 vs. the S&P’s growth to $1.05.
for 5 year periods, small value outperformed the S&P 69.2% of the time. The small value worst case 5-year period shrunk $1 to $.17 vs. $0.38 for the S&P. Since 1950 the worst case for small value stocks is a shrinkage to $0.70, only slightly lower than that of the S&P ($0.81).
James Haltiner is Professor of Business Administration at the College of William and Mary, where he has taught corporate finance, investments, and quantitative methods courses for thirty years. Previously he taught at the McIntire School and at the Darden Graduate School of the University of Virginia. He earned a BA in mathematics, MBA and DBA from the University of Virginia. His research interests are in financial valuation and portfolio management issues, and he has consulted with or served as an expert witness for a number of public and private organizations about financial valuation, financing, and investors’ opportunity cost of capital, and in matters of utility rate regulation. From 1987-1993 he was a member of the state of Virginia's pension fund Investment Advisory Committee. He currently serves on the asset and pension committee of a regional health care system. As an Associate with the Vantage Consulting Group he advises several other endowments and pensions in matters of investment portfolio management.