Are Small Cap Equities Still Worth It?

by
Miles Savitz

Small caps are cheap compared to the valuation multiples for large cap equities currently. Small cap returns have trailed large caps over the past decade, creating a historic gap between the valuations of large and small cap stocks. The last time this happened was in 2000, and small caps outperformed large caps over the next decade plus. But can history repeat itself?

One of the main reasons why small caps historically did better than large caps was the handful of stocks each year that achieved huge success and grew into large caps. However, the percentage of small caps that have achieved that massive success has greatly decreased over the last 20 years. The main problem is that there are fewer public companies, dropping from about 8,000 in the late 1990s to about 4,500 now. Private equity and venture capital are among the main factors for the decline in public companies. Small companies no longer need to go to the public markets for funding but can instead rely on PE and VC dollars. Small companies can grow into massive market caps without ever touching the public markets.

There have also been the effects of big tech’s acquisition of small tech companies. To maintain market share, large tech companies will buy competitors before they have time to grow. Exciting products and services that once would be available to small cap investors are now being acquired before they have an opportunity to grow. The small cap segment has always had risk due to the higher risk of going bankrupt, but small cap stocks once had a premium over large cap due to the outperformance of a few names.

Small caps will continue to underperform unless regulation changes, because the already unlikely chance of finding a winner is now even unlikelier, as companies stay private longer or get acquired by big tech early on in their life cycle.


DISCLOSURES

The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.

This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.

Smaller capitalization securities involve greater issuer risk than larger capitalization securities, and the markets for such securities may be more volatile and less liquid.  Specifically, small capitalization companies may be subject to more volatile market movements than securities of larger, more established companies, both because the securities typically are traded in lower volume and because the issuers typically are more subject to changes in earnings and prospects.

Securities of small and medium-sized companies tend to be riskier than those of larger companies. Compared to large companies, small and medium-sized companies may face greater business risks because they lack the management depth or experience, financial resources, product diversification or competitive strengths of larger companies, and they may be more adversely affected by poor economic conditions. There may be less publicly available information about smaller companies than larger companies. In addition, these companies may have been recently organized and may have little or no track record of success.

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