TCS Daily

Don't Forget Small Caps

By James K. Glassman - September 18, 2000 12:00 AM

Recently I wrote about ten great tech companies for the long haul. I think America's large, high tech leaders are outstanding investments for those who plan to buy and hold. And of course many of you agree. But along with some great tech names, every investment portfolio should also include balance - balance among different industries, different countries, and different sizes of firms.

Smaller companies in the stock market are known as small caps because their market capitalizations are typically measured in the hundreds of millions of dollars, whereas large caps are valued in the tens and even hundreds of billions. Small caps as a group haven't been a very popular investment vehicle in recent years - they've generally lagged behind the big corporate names.

However, this year things are changing, and history says that you'd do well to put some of your money into small, publicly traded companies. A good proxy for small caps is the Russell 2000, an index of the 1001st through the 3000th largest companies in America by market value. While we hear a lot about the big corporate names, it may surprise you to learn that this year the Russell 2000 is handily beating the S+P 500, the Dow and the NASDAQ composite.

This could be the beginning of a trend. Historically, small caps actually do better than large caps. Ibbotson Associates, the excellent Chicago research firm, has tracked the performance of all classes of stocks over time, with some interesting results. For the years 1926-1999, small caps delivered an average annual return of 12.63%, edging out the large caps, which returned 11.35% during the same period.

In contrast, during the specific period of the 1990s, the big companies trounced the little guys in investment performance. For the decade of the 1990s, the S+P 500 beat the small caps by an annual average of 3 whole percentage points - 18.2% for the big guys and 15.09% for the small caps. And the big company dominance was even more dramatic during the five-year period ending in 1999. For the years 1995-1999, large caps returned a sizzling annual average of 28.55%, while the small caps delivered just 18.49%. In any other era, of course, returns of better than 18% per year would be cause for celebration, but in these wonderful times of ours it's been mediocre. So small caps have been out of favor.

Knowing that large caps have had an amazing run in recent years, and knowing that history gives the edge to small caps over the long haul, you can react to this information in one of two ways. You can either say that the markets have changed, that the New Economy gives particular advantages to huge corporations, that our global markets now favor multi-national giants - or you can say that small caps are due for a run and large caps are due for a fall. If you're of the mindset that the markets have permanently changed to favor the big guys, remember the old saying on Wall Street: The most dangerous four words in investing are, "This time, it's different."

Actually, I'm not saying that I think the big guys are headed south. As regular readers know, I'm an unrepentant tech bull and I love buying great firms for the long term. But only a foolish investor ignores the potential riches to be found in small caps.

I always urge people to buy and hold, but buying for the long term is particularly important with small caps, because history shows that they are extremely volatile - so don't venture into this territory if you're playing with your 17-year-old's college fund.

How to invest? If there's a company that you love that makes a great product, there's nothing wrong and practically everything right with buying the stock.

TCS Daily Archives