For Big Gains, Think Small

The vast majority of investors regret not having bought Wal-Mart (NYSE: WMT) or Microsoft (Nasdaq: MSFT) 20 years ago, long before they became the behemoths they are today. Consider this, though: Many investors in 20 years from now will probably look back at the opportunities available in today’s market with a similar sense of regret.

Without a doubt, the giants of tomorrow are out there right now — and there is still time to act.

Of course, finding future leaders is never easy. In all likelihood, the companies that will deliver the biggest gains over the next 20 years are probably quite small today.

This is because stock prices are a derivative of earnings growth. It stands to reason that a small company with $10 million in earnings can double or triple that figure far quicker and easier than a corporate giant with $10 billion in earnings — richly rewarding its shareholders in the process.

#-ad_banner-#Long-term performance numbers bear this out:

During the past 10 years, small-cap companies have outpaced their large-cap counterparts. In fact, the Russell 2000 Index has delivered an impressive +46.6% more than the S&P 500. 

Meanwhile, over the same time frame, value stocks have soundly outperformed growth stocks.

At the confluence of those trends, the small-cap value sector has been one of the single best performing asset classes.

Of course, markets are cyclical, and anything can happen over short periods of time. Therefore, long-term performance figures tend to have far more predictive power.

On that front, small-cap value stocks still look superior . . .

1969-2002 Annual Returns Value Stocks Growth Stocks
Large-Cap +10.8% +9.2%
Small-Cap +14.8% +8.4%

As the table shows, small-cap value stocks averaged +14.8% annual clip during the 33 year period, according to a recent study. Yet during the same time period, large-cap value stocks averaged only a +10.8% annual gain.

Over the long haul, that difference can add up to a substantial amount of money.

Growth of $10,000 10 Years 20 Years 30 Years 40 Years
Large-Cap Value (+10.8%/year) $27,886 $77,766 $216,866 $604,770
Small-Cap Value (+14.8%/year) $39,757 $158,065 $628,429 $2,498,477
Difference $11,871 $80,299 $411,563 $1,893,707

Based on the 20-year time period shown above, investors in small-cap value stocks would have earned an additional $80,299 when compared to investors who placed their money in large-cap value stocks. And over an 40-year time period, that figure jumps to $1,893,707 in additional returns!

It seems pretty clear: if you want to maximize returns over the long haul, then you need to have exposure to small-cap value stocks.

P.S. You don’t make money in the market by taking risks… you make money by minimizing them. That’s why I like to skew my investments toward a set of “rules” that have proven to beat the market over and over again. Like the “small-cap value” vs. “large-cap value” rule I explained above. You might prefer a different set of rules for your investing style. If you’re an income investor, you should definitely consider following these eight “no-brainer” rules. One man is already collecting about $3,000 a month in dividends this way.