Do small-cap stocks tend to outperform large-cap stocks?
Key Takeaways. Small-cap stocks tend to grow at faster rates than their large-cap counterparts. They can also lose profit more quickly due to their size. Large-cap customer bases are by definition larger, and so small-caps tend to focus heavily on increasing that base.
Small-cap stocks have historically outperformed their larger counterparts, but investment into this asset class should be approached with caution and suitable risk tolerance. They tend to offer higher returns in exchange for higher investment risk.
Small-cap value stocks have, however, outperformed large-cap companies over the last 20 years, indicating that small-caps are an attractive asset class for long-term investors.
Large-cap corporations, or those with larger market capitalizations of $10 billion or more, tend to grow more slowly than small caps, which have values between $250 million and $2 billion.
Large-cap funds are less risky than small and mid-cap funds. Small and mid-cap funds have higher growth potential than large-cap funds. Large-cap funds are good for conservative investors. Mid and small-cap funds are suitable for medium-risk takers to aggressive investors.
A Slowing Economy Could Keep Small Caps Down
A slowing economy is “not particularly favorable for small caps,” Clissold says, as they tend to outperform at the beginning of a bull market or economic expansion.
The small firm effect theory posits that smaller firms with lower market capitalizations tend to outperform larger companies. The argument is that smaller firms typically are more nimble and able to grow much faster than larger companies.
A key reason for this is that small caps have struggled in the high interest rate environment more than large companies. Small caps tend to be more focused domestically with earnings growth often closely tied to how the U.S. economy is performing or sentiment about how the economy will perform.
History shows that U.S. small-cap companies tend to outperform their larger counterparts when inflation and interest rates rise.
According to Aswath Damodaran, historically, small-cap stocks have outperformed large-cap stocks during periods of high inflation, such as the 1970s.
Is small-cap more risky than large-cap?
Key Takeaways. Small-cap stocks tend to offer greater returns over the long-term, but they come with greater risk compared to large-cap companies. The greatest downside to small-cap stocks is the volatility, which is greater than large-caps.
Understanding Small-Value Stock
The Fama and French model expands on the capital asset pricing model (CAPM) by adding size and value factors to the CAPM's market risk. The Fama and French model suggests that small-cap stocks generally tend to outperform the markets, over and above large-cap stocks, on a regular basis.
Small caps refer to companies with a market capitalization ranging from $300 million to $2 billion. The stocks of small caps are prone to wide market fluctuations; hence, these are highly risky investments.
Lower risk: Compared to mid-cap and small-cap funds, large-cap funds invest in well-established companies with larger market capitalizations. These companies tend to be more financially stable and resilient to market fluctuations, offering a lower overall risk profile.
Key Takeaways. Large cap stocks are valued at greater than $10 billion in the market, making them more stable and mature investments. As a result, large cap stocks typically have lower volatility, greater analyst coverage, and perhaps a steady dividend stream.
Key Takeaways. Rising interest rates proved to be a strong headwind for global small-caps and other longer-duration risk assets, but those trends may be reversing. Analysts forecast that 2024 earnings for small-cap companies will grow faster than large-cap earnings in most regions.
The small-cap value asset class has also achieved better earnings growth and capital returns than other asset classes, including small-cap growth, large-cap value, and large-cap growth, while maintaining attractive valuations.
Risk. Small-cap mutual funds are very risky. This means that in the short term, investing in them could lead to short-term losses.
The small-cap effect – the idea that smaller companies offer higher risk-adjusted returns than larger ones – has been a topic of interest since Rolf Banz's 1981 paper. While the concept has influenced investment strategies and academic research for years, it has also faced its share of challenges and revisions.
Credit risk — The cost of borrowing is higher for smaller companies. Indeed, the cost of equity is higher, too. Lower average valuations for share buyers translate into higher cost for the companies issuing those shares. This is consistent with the underperformance of smaller company shares when times are tough.
Are small caps more cyclical?
History shows that smaller-cap stocks are much more closely tied to the domestic economic cycle than larger-cap stocks.
One is that, when it comes to trading, small-cap stocks have less liquidity. 3 For investors, this means enough shares at the right price may be unavailable when they wish to buy—or it may be difficult to sell shares quickly at favorable prices.
They might exaggerate—or even invent—its products or capabilities, perhaps capitalizing on current events or market trends to appeal to investors. The potential combination of minimal information and low trading volume can also make it easier for bad actors to manipulate a stock's price to their advantage.
We expect earnings to drive the next leg higher for small caps. According to FTSE Russell, analysts anticipate that expected earnings growth among companies in the Russell 2000 will rebound by 28.2% in 2024, after an expected decline of 11.2% in 2023. The timing depends somewhat on the ultimate path of the US economy.
In an analysis of foreign and U.S. investments from December 1998 through June 2023, researchers at index provider MSCI found that small-cap stocks outperformed large firms over 15-year periods about 9 in 10 times.
