Interesting article in NY Times by Mark Hulbert on the "long-running mystery": why small-cap value stocks tend to outperform large-cap growth stocks. Mr. Hulbert cites research studies, esp. by R. Arnott in a recent Financial Analysts Journal article.
As I understand it, the basis of the argument is that some stocks are overvalued and some are undervalued at any given point. The overvalued stocks will have larger market capitalization and price/book ratio than they would have if they were not overvalued. Portfolios of large growth stocks will have a "disproportionate number" of these overvalued (larger market cap)stocks. Small-cap value portfolios - because they seek low p/bk, and they fish in a low-cap pond , will thus have the less overvalued, more undervalued stocks. A portfolio with overvalued stocks should do worse than the market; a portfolio with undervalued stocks should do better than the market (over a long time frame).
"Notice that this argument does not depend on anyone being able to identify the particular undervalued or overvalued companies. Nor does it depend on a specific definition of fair value. All that is required is that some stocks are overvalued and some are undervalued."
Mr. Hulbert offers two conclusions:
1.Investors should favor small-cap and value stocks.
2. Because most index funds are market cap. weighted, they therefore over emphasize that very segment where stocks are more likely to be overvalued. Index funds would show better results if the stocks in them were equally weighted, not bought in proportion to their market cap.
I offer a third idea. If:
"... this argument does not depend on anyone being able to identify the particular undervalued or overvalued companies. All that is required is that some stocks are overvalued and some are undervalued."
I infer from this it might not be necessary or even possible to correctly identify undervalued or overvalued companies. (There's no consensus definition of value as used by the many thread members here in their stock picks.) It may be a matter of just getting "some" undervalued stocks in one's portfolio, and getting more of those in than "some" incorrectly chosen overvalued stocks. If that's so, then it's possible that better performance could be achieved by making more picks and thereby giving oneself more chances that one is loading the portfolio with "undervalued" winners than "overvalued" laggards. Or perhaps, if one is consistent in how one selects stocks, number of stock selections is irrelevant - the proportion of undervalued in a small-cap value portfolio will remain the same regardless of number of picks (assuming some minimum number).
Anyway, I continue to be a believer in lots of diversity so I will look at and buy large-cap stocks occasionally.
And I'm not one who believes that portfolio performance decreases as number of stocks increase. I don't see that concentrated portfolios outperform and/or are better than those portfolios which contain MANY stocks. Although lately... for a diverse guy... I'm getting pretty heavily loaded with oil/gas stock purchases. -g- |
