Better Return on Investment Shown for Quality Small Stocks

By Cunniff, John | THE JOURNAL RECORD, June 14, 1990 | Go to article overview

Better Return on Investment Shown for Quality Small Stocks


Cunniff, John, THE JOURNAL RECORD


Long-standing records suggest clearly that sound investments in quality small stocks can produce much better returns than portfolios consisting only of large-company stocks.

The very idea tends to challenge conventional thinking, because you seldom hear about the little fellas but you can't escape hearing about the big boys who make up the popular stock market averages.

The big brokerage houses research and promote big stocks. Mutual funds and pension funds buy them. Business magazines interview big-company managers. Big company products are advertised wherever people can see or hear.

But the records show one area in which the little guys beat the big guys: The little guys, as a category, often can produce bigger returns for investors than the big fellows. And they've been doing it for many years.

Several research projects demonstrate this, but probably the first of them was by Rolf Banz, a doctoral student at the University of Chicago in 1978, who examined all New York Stock Exchange stocks by size for every year in the period 1931-74.

He determined size by multiplying shares of each stock by share price. He ``invested'' equal dollars in each company in the bottom 20 percent, ranked by market value. Each year he revised the list to include only the smallest.

Banz found that in that period his hypothetical portfolio produced about a 5 percent better annual rate of return than the market as a whole. Others later found a similiar effect, although not always by the same percentages.

Five percent might not seem like much, especially at a time when some folks aren't happy if they realize that kind of gain in a month. But time is the forgotten factor of investing, and 5 percent over the years adds up beautifully.

Gerald Perritt, investment adviser, mathematician and author of a book on the small-firm effect, calculates that in the 60 years 1926-85 the Standard & Poor's 500-stock index had a compound annual return rate of 9.8 percent, vs. a 12.6 percent compound annual rate for the so-called small stocks. …

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