Be on Lookout for Small Caps

A short and punchy note today. Recent data speaks to money flows and trends favorable to small company stocks. 

Taking a step back, at most basic, small companies (when successful) become large companies – a good thing. Also, small company stocks are bought much cheaper (lower ratios of price to book value) in the marketplace. The caveat is that small companies typically have less of a track record and can be more volatile.

According to recent performance data* small company stocks over the past month are indicating at least modest confidence in the economy as well as decent performance ahead versus the largest growth companies. Of course, a month of positive performance does not a trend make. BUT based on historical performance (see chart above) small companies – over the longer term – reward the more volatile ride.

Looking back at last year the rising interest rate environment made it more difficult for smaller companies (and some technology companies) to access capital easily due to higher borrowing rates, and that hurt performance. Higher rates tend to be a risk for small companies. But as higher rates become more “normal”, and the economy slowly adjusts to the overall rate environment – and if the economy chugs along – companies in general can thrive. Smaller companies, especially, can be picked up more cheaply and markets eventually recognize these factors in the form of relatively higher prices.

There is a form of a waiting game in times of rising interest rates. But when buying cheaper companies (cheaper in terms of ratio of price to book value), there is less risk of overpaying for a stock in the short-, intermediate- and longer-term. Please ask me about these concepts.

*Charley Grant. The Wall Street Journal, June 22, 2023.


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