Why Small-caps Will Win Over Large-caps
Editor’s Note: Today we want to share an interesting article with you about the big stocks vs small stocks argument. The article was originally published about three weeks ago… and while the markets are down a bit since then, i believe this original argument is still valid! Give it a read and let me know what you think.
I spend a lot of time looking at stock charts.
The stock screener I use has a chart, current fundamental data, and recent news right in one easy to view page. So, even if Im looking for fundamental data or a recent news item about the stock, I still end up looking at the chart.
One thing thats been clear for some time is the role a companys market-cap has played in its performance.
Time after time Ive looked at different companies in the same sector, industry, and in the same line of business as one another. The stocks often have similar fundamental data.
The only distinguishing factor is their size of the company or market capitalization. Yet, the stock performance this year has been wildly different for large-cap stocks than it mid- and small-cap stocks.
Take a look at these charts showing the year to date performance of the large cap SPDR S&P 500 (SPY), SPDR S&P MidCap 400 (MDY), and iShares Russell 2000 Small-Cap ETF (IWM).
As you can see SPY has been trending higher throughout the year and its currently up about 8% YTD.
MDY has also been trending higher this year but at a slower pace. Its currently up a little more than 3%.
And finally we have IWM, the small-cap ETF. Its had an up and down year and its clearly not in an uptrend like SPY or MDY and it currently down 3.6% so far this year.
Ive been looking into why small-cap stocks have been underperforming relative to large-cap stocks and there are lots of opinions on the subject.
Some point to the fact that small-caps are more expensive based on earnings per share. Others say small-caps are just more volatile than large caps.
And those can certainly play a role in their performance. But the reason I see as the biggest driver of the underperformance of small-cap stocks relative to large-cap stocks is stock buybacks and M&A activity.
Simply put, large companies have more money and power to engineer per share earnings growth than small companies.
Large-cap stocks have been aggressively buying back their own stock. And theyre using the ultra-cheap corporate debt to acquire companies that are accretive to per share earnings.
Heres the thing
These stock buybacks and M&A deals that is helping boost large cap earnings today will likely come back to bite them down the road.
Dont forget that the money theyre spending on these buybacks could be spent on building the foundation for future revenue and earnings growth.
But theyre not building anything theyre piling on cheap debt and driving earnings per share by reducing the number of shares. And while that shows up as growth, its not the same thing as growing the amount of money they make.
Heres the interesting part
The fact that small cap companies dont have the pile of cash or access to ultra-cheap credit like the really big companies could work out in their favor.
Right now, small cap companies are being punished because they cant grow earnings per share as fast as large cap stocks. And the reason they cant is because they cant buy back their own stock at the same rate as these much larger companies.
The thing small cap companies are doing is investing in their future. Theyre building their asset base and doing the things that real earnings growth depends on.
Heres the upshot
Small-cap stocks are out of favor with investors right now because their recent performance hasnt kept up with their large-cap brethren. But when you dig into whats driving the performance of the stocks it appears that small-cap stocks are the ones doing the things to deliver legitimate long term earnings growth.
Good Investing,
Corey Williams
Category: Investing in Penny Stocks
