ONE OF THESE DAYS FUNDS INVESTING IN SMALL-CAP COMPANIES ARE GOING TO SIZZLE AGAIN
Lately, many of the rewards in the stock market have gone to those investing in large-cap stocks. But since the market is fickle and cyclical, there's bound to come a time when the now ugly duckling small caps have their day in the sun.
Look back at all the really long-term performance numbers----those in which the figures used in calculations begin in the mid- to late 1920s and end in late 1990s---and top performance kudos always go to small-cap stocks. Typically they beat-out large-cap companies by a couple of full percentage points. But again, that's the long-term story. Currently, investments in funds that invest in small-cap stocks haven't given their shareholders anything to crow about.
During the first quarter of this year, for example, the average small-cap fund was down about 5.7 percent, according to Lipper, Inc. Over the past year the results are worse---down 15.3. Ouch.
But, if you'd been a long-term holder of a small-cap fund, the average annual total returns aren't quite as dismal: For the past 10 years, for instance, the average small-cap fund has returned on average 13.2 percent per annum to its shareholders.
So why even consider investing in small cap funds given their recent history? One reason, numbers show they are primed to pop someday.
"The relative valuations on small cap stocks are at all-time lows compared to large cap stocks," says Steve Norwitz, a vice president at T.Rowe Price.
Norwitz said that usually small companies have price/earnings ratios that are higher than large companies. Using the New Horizons Fund, (1-800-225-5132), as a barometer, every time its P/E ratio has fallen below that of the S & P 500 in the past, periods of outperformance by the small caps follow.
James Broadfoot is portfolio manager of the Ivy U.S. Emerging Growth Fund, (1-800-777-6472). About 80 percent of the fund's 140 stocks in it have market capitalizations of under $1 billion. He too says that the relative valuations on some of the small cap stocks are compelling.
"You can buy some of these small cap growth stocks at way under their growth rate so you don't need their P/E's to expand. If they (P/E's) just stay constant and you get 25 to 30 percent earnings growth, that's how much the stock goes up, " says Broadfoot. " So it's not like you need multiples to expand for these stocks to do well."
But what if you're already a small-cap fund owner, and your fund's performance has been underwater, how long do you hold on to a losing small-cap fund? "Well that's the thing," says Norwitz. "Historically the performance cycle of small caps on the plus side is strong enough that it more than offsets the lagging periods."
The pros say that small-cap stock performance cycles historically last three to seven years. From 1991 to 1994, the last time small-cap stocks were in favor, the annualized return on them was 30.8 percent, according to figures from T.Rowe Price, well outperforming the S & P 500 index. From 1975 to 1983, these stocks had an average annualized return of 33.6 percent. Again, handsomely outperforming the large caps.
So if you're a long-term investor and sitting with what looks to be a dog of a small cap fund, the best advice most pros will give today is to stay put. Selling off those fund shares now could mean selling at the bottom---or close to it---and missing the someday rally in that sector.
For new investors who follow cycles or like to find value opportunities in the stock market, bargains abound in the small-cap arena. And one day the small-cap fund investor will likely profit again. The problem is, nobody knows precisely when.
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