15 small stocks with big dividends that can grow even after the small-cap rally fades
Think twice before shifting your stock portfolio toward smaller-cap names
The small-cap stock rally doesn't look like it will get much bigger.
You should think twice before shifting your stock portfolio toward smaller-cap names.
Small-cap stocks' spectacular rally over the past week does not mean market leadership is shifting from the large caps more than just temporarily.
A more permanent shift has been anticipated for at least a decade, based on the prior 90 years in which U.S. small-caps significantly outperformed their large-cap counterparts - a pattern known as the small-cap effect. From 1926 up until a decade ago, the 10% of publicly-traded stocks with the smallest market caps outperformed the largest-cap decile by 3.1 annualized percentage points. Since then the reverse has been the case, with the largest-cap stocks outperforming the smallest-cap decile by more than five annualized percentage points.
The small-cap stock rally doesn't look like it will get much bigger.
You should think twice before shifting your stock portfolio toward smaller-cap names.
Small-cap stocks' spectacular rally over the past week does not mean market leadership is shifting from the large caps more than just temporarily.
A more permanent shift has been anticipated for at least a decade, based on the prior 90 years in which U.S. small-caps significantly outperformed their large-cap counterparts - a pattern known as the small-cap effect. From 1926 up until a decade ago, the 10% of publicly-traded stocks with the smallest market caps outperformed the largest-cap decile by 3.1 annualized percentage points. Since then the reverse has been the case, with the largest-cap stocks outperforming the smallest-cap decile by more than five annualized percentage points.
There are two reasons to be skeptical that the tide has turned in a permanent way.
The first is that, spectacular as the small-cap surge has been over the last week, past rallies of similar magnitude did not necessarily usher in a new era of small-cap dominance. On at least two occasions in mid- and late 2020, for example, the Russell 2000 RUT Index produced a five-session gain that was even larger than the 11.2% gain it has registered over the past week. And yet, since then, large caps have outperformed small caps by near-record margins.
The other reason to be skeptical is that researchers now believe that the small-cap effect may have never really existed in the first place. I reviewed this research in a recent column for Barron's. Based on a new dataset extending back to 1866, small-cap stocks in fact did not beat large-cap stocks on average, even over the period prior to the last decade. Rather than the past decade being an exception, in other words, it is consistent with the long-term pattern.
The first is that, spectacular as the small-cap surge has been over the last week, past rallies of similar magnitude did not necessarily usher in a new era of small-cap dominance. On at least two occasions in mid- and late 2020, for example, the Russell 2000 RUT Index produced a five-session gain that was even larger than the 11.2% gain it has registered over the past week. And yet, since then, large caps have outperformed small caps by near-record margins.
The other reason to be skeptical is that researchers now believe that the small-cap effect may have never really existed in the first place. I reviewed this research in a recent column for Barron's. Based on a new dataset extending back to 1866, small-cap stocks in fact did not beat large-cap stocks on average, even over the period prior to the last decade. Rather than the past decade being an exception, in other words, it is consistent with the long-term pattern.
Once you focus only on higher-quality companies, the small-cap effect still exists.
All hope is not lost for small-cap stocks, however, according to a major study from several years ago entitled "Size Matters, If You Control Your Junk." The authors, all from AQR Capital Management, were Cliff Asness, Andrea Frazzini, Ronen Israel, Tobias Moskowitz and Lasse Pedersen.
They found that the average return of the small-cap sector has been brought down by the many small-cap stocks of companies with low financial quality - junk, in other words. Once you focus only on higher-quality companies, the small-cap effect still exists. The authors of the study considered a stock to be higher quality if it scored highly on several dimensions, such as profitability, profit growth, beta and dividend payout ratio.
All hope is not lost for small-cap stocks, however, according to a major study from several years ago entitled "Size Matters, If You Control Your Junk." The authors, all from AQR Capital Management, were Cliff Asness, Andrea Frazzini, Ronen Israel, Tobias Moskowitz and Lasse Pedersen.
They found that the average return of the small-cap sector has been brought down by the many small-cap stocks of companies with low financial quality - junk, in other words. Once you focus only on higher-quality companies, the small-cap effect still exists. The authors of the study considered a stock to be higher quality if it scored highly on several dimensions, such as profitability, profit growth, beta and dividend payout ratio.
To appreciate how important it is to control for junk, l applied the researchers' criteria to the stocks currently in the Russell 2000 index. To make it into the "high quality" category, I assumed that a stock had to rank above the median in each of the individual dimensions. Out of the 2,000 stocks in the index, just 15 stocks survived. They are listed alphabetically in the table below.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited.
He can be reached at mark@hulbertratings.com
More: These small-cap stocks score highest when screened for quality
Also read: This small-cap stock-market rally is remarkably strange. That's why it has 'further to run.'
-Mark Hulbert
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