Small-company stocks tend to light the way out of economic downturns, though many investors miss out on the gains. That's because investors flee...
Small-company stocks tend to light the way out of economic downturns, though many investors miss out on the gains. That’s because investors flee small caps for larger companies they consider less risky as the economy heads south.
Post-recession returns for small-capitalization stocks are historically better than for large-caps, says Jonathan S. Vyorst, portfolio manager for the small-cap Paradigm Value Fund (PVFAX).
“The perception of safety and actual safety are two different things,” he says.
While stocks of all sizes tend to tick up just before a recession ends, small caps — those with market caps of $3 billion or less — tend to post the best returns, as investors are willing to take more risk, says Merrill Lynch small-cap strategist Steven G. DeSanctis.
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Small caps have outperformed large caps this year and since the market’s recent bottom March 10. This means investors think the slowdown, which many people believe is a recession, is coming to an end, DeSanctis says.
Larger companies are considered steadier because their revenue is more diversified and they often have easier access to capital.
DeSanctis says small companies’ exposure to booming overseas markets is growing. But they still derive only about 12.3 percent of revenue from abroad, compared with 24.8 percent for large caps.
“They still have a good portion that is domestically focused,” says DeSanctis.
But Vyorst points to small caps with significant overseas revenue, such as Phillips-Van Heusen (PVH), which owns the Calvin Klein clothing brand, and industrial manufacturer Lincoln Electric Holdings (LECO).
“I don’t think large means anything but complicated,” he says.
DeSanctis thinks it’s too soon to jump into small caps and notes the stocks look pricey. The price-earnings ratio for the Russell 2000 small-cap index is about 16.3, versus 14.8 for the large-cap Standard & Poor’s 500.
Historically, the difference is only 0.3 point, DeSanctis says.