Is There a Small-Cap Premium?

Josh Brown highlighted an interesting post by Alex Bryan at Morningstar, “Does the Small-Cap Premium Exist?”

Bryan touches on a few important points which I’ve long suspected. The long-term data suggests that small-cap stocks outperform their larger-cap bretheren.

This is a good example of the fact being true, but it needs more context. The outperformance of small-caps has historically been very erratic. We’ve gone for many years, decades in fact, with small-cap stocks underperforming.

The data also shows that most of the outperformance comes during the month of January. This is suspicious and it tells me that something else is going on. Perhaps beaten down small-caps are subjected to tax-loss selling.

Bryan notes that there hasn’t been a small-cap premium over the last 30 years, nor does it appear in other countries. He thinks that liquidity may have played a role in shaping the historical data, and that may not play such a large factor in the future.

I suspect that there is a small-cap premium but it’s very small and not very stable. I also think it’s more visible among small-cap value stocks than small-cap growth issues. There are lots of values to be found among small-caps but I would never buy a stock because it’s small.

We often talk about the stock market as if it’s one entity, but that’s very misleading. The bull market of the late-1990s was heavily skewed to large-cap stocks. Morgan Housel writes, “In 1999, one of the best years for the market ever, more than half of stocks in the S&P 500 declined. Two companies, Microsoft and Cisco, accounted for one-fifth of the index’s return.” People speak of the terrible stock market from 2000 to 2009, but small-cap value stocks didn’t do so poorly, because they had been so badly left behind.

Posted by on January 27th, 2014 at 3:25 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.