Small Cap Stocks Performance

Historically, small-cap stocks have been shown to outperform the rest of the market over the long term. And, small-caps tend to underperform during bear markets but outperform in bull markets.

Some of the best stocks to buy in the past 25 years started as small-cap stocks. Amazon was a $7 stock in 1998, and Tesla had a market valuation of just over $1 billion in 2010. Of course, not every small-cap company becomes a giant. Investing in small companies can be rewarding, but it also comes with risks that investors need to understand.

Over the long-term, small caps tend to outperform because of greater growth opportunities. A massive company is limited by its existing size. It’d be exceptionally difficult for, say, Apple Inc. to triple its revenues and free cash flow anytime soon.

However, a $1 billion company can much more easily grow to be multiples of its current size. Many small caps stay small because they have structural problems, management lacks the capability to grow the business, or their niche simply isn’t large enough to support a bigger enterprise. That said, many small caps can graduate to greater things, earning shareholders tremendous returns along the way.

Small-cap stocks tend to experience more price volatility and to suffer more stock price destruction than their larger cap peers during bear markets and when equities are broadly struggling due to inflationary and recessionary fears.

Small cap stocks typically underperform entering recessions and periods of economic weakness but outperforms coming out of them. In the long run, small caps tend to be winning investments. Yale professor Roger Ibbotson and financial consultancy Duff & Phelps analyzed nearly a century of data to find that small caps have outperformed large companies by 1.6% on average every year through 2020.

Fearful investors who throw in the towel during market downturns risk missing out on the rewards when the market possibly reverses course in 2023.

“This is one of the best times to invest in small company stocks that we’ve seen in a very long period of time,” says Gregg Fisher, founder of global small cap hedge fund Quent Capital, which manages $1 billion in assets. “The odds historically of a huge rally off this massive decline are high.”

The small-cap benchmark Russell 2000 Index (RUT) generated a total return (price appreciation plus dividends) of -20.4% for the year-to-date through Dec. 16. That trailed the S&P 500’s (SPX) total return of -17.9%.

No surprises there. Risker and “growthier” equities such as small-cap stocks tend to underperform when markets are volatile and headed south (bearish).

By the same token, however, small-cap stocks also tend to outperform the broader market when equities are catching a bid. No one can know for certain if we’ve already seen the bottom of our current bear market. Once the equity malaise lifts, however, the best small-cap stocks to buy should theoretically be among the market’s top outperformers.

To find the best performing small cap that have continued to grow through the bear market, Search for companies with a market value between $300 million and $2 billion that also had positive sales growth over the past 12 months and a share price of at least $5. Financial institutions, REITs, utilities, royalty trusts and limited partnerships were excluded, as were companies that have been public for less than one year.

Over time, small-cap stock prices tend to be more volatile than those of larger companies, and stock values fluctuate more dramatically. But, in general, the longer the evaluation period, the greater the likelihood that small-cap stocks outperform the large-caps.

in recent months small-cap stocks have fallen sharply amid a broader pullback on fears of a Federal Reserve Board rate hike, especially in high-priced growth stocks. Since small-cap stocks are more likely to be in their growth phase and are often unprofitable or minimally profitable, they get hit harder during “risk-off” moments like the one that started 2022. In other words, small-caps tend to underperform during bear markets but outperform in bull markets.

References:

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