Small stocks are no better than big stocks

Historically, small stocks beat big stocks. But the better gains of small stocks was due to one unusual nine-year period. Big stocks should keep up with small stocks.

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Small stocks scored their “lucky shot” in a nine-year period from 1975 thru 1983. But over time, big companies have better access to financing and can survive cyclical downturns.

At first glance, it appears that small stocks do much better than big stocks. But look closer and both groups do about the same most of the time.

From 1926 through 2006, small stocks (as measured by the Russell 2000 Index and its predecessors) delivered average yearly compound returns of 12.21 per cent. Over these 81 years, big stocks (measured by Standard & Poor’s 500 Stock Index) produced average yearly compound returns of 10.26 per cent.

Over long-periods of time, even small differences in percentage compound returns make a big difference. A thousand dollars invested in small stocks in 1926 would’ve grown to $11.25 million at the end of 2006. A thousand dollars put in big stocks over the period would’ve grown to only $2.736 million. What would you do with an extra $8.514 million?

But to earn that extra $8.5 million, you would’ve had to hold small stocks from 1975 through 1983. That’s the finding of Jeremy Siegel, professor of Finance at The Wharton School of the University of Pennsylvania and author of Stocks for the Long Run.

Big company stocks are safer

Had you stayed out of stocks in the nine years from 1975 through 1983, you would’ve earned far less. Your small stocks would’ve generated average yearly compound returns of 9.61 per cent from 1926 through 1974 and 1984 through 2006. That’s basically the same as big stocks’ average yearly compound returns of 9.59 per cent over the same periods.

In fact, from 1926 through 1959, big stocks beat small stocks. Professor Siegel writes, “Even by the end of 1974, the average annual compound return on small stocks exceeded large stocks by only about 0.5 per cent per year, not nearly enough to compensate most investors for their extra risk and trading costs.”

The appeal of small stocks is that highly-successful small companies can turn modest investments into fortunes. Consider Walmart Inc. It grew from one store in a town in Arkansas into the world’s largest retailer at one time. Also, a top-selling product has more impact on a small manufacturer than a big manufacturer. Even so, small companies are generally riskier than big companies.

For one thing, big companies have often survived past cyclical downturns. Consider, for instance, US Key stock 3M Company. In 3M’s 118-year history, it has survived downturns, including the Great Depression of the 1930s and the recent Great Recession. This recent recession is the first real test for some small companies. Especially those that listed their stocks after the recession of the early 2000s.

Another plus with big companies is that they often have better access to financing. Moody’s Investors Service, for instance, gives 3M its top credit rating. Small firms often find it hard to raise needed credit.

Big companies are usually more diversified. 3M operates in over 70 nations, which cuts its exposure to any one market. Also, 3M sells over 50,000 products, which cuts its dependence on any one product.

Big companies often attract the best and brightest managers. In addition, governments have shown they’ll bail out companies that are ‘too big to fail’. Small firms, by contrast, must survive on their own.

We now expect big stocks to beat small stocks. That’s because many investors have become wary of a stock market setback. Many will demand a higher degree of safety.

This is an edited version of an article that was originally published for subscribers in the October 29, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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