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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era
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To: Bob Rudd who wrote (695)8/29/1998 11:13:00 AM
From: porcupine --''''>  Read Replies (1) of 1722
 
Boyd: I agree with Bob's comments regarding the relative outperformance of small caps in the 70's. Other factors are the reverse situation of the 1990's:

1. Small caps had less exposure to the difficult overseas conditions of the 1970's; and

2. A greater percentage of U.S. large caps in the 1970's were "smokestack industries" that were more affected by rising energy costs and, being leveraged and capital intensive, had increasing costs of replacing capital as inflation increased both the price of new equipment and the interest rates charged for financing it. (These factors were crucial in converting Buffett from seeking "cigar butts" to seeking companies with low capital replacement costs.

But, while we're on the subject, there's a measurement bias that favors large caps over small caps in long term comparisons. The most successful small caps eventually outgrow small-cap status and therefore are no longer counted as such. Yet, the investor who bought and held them when they were still small does much better than the small cap Index would suggest.

The bias is pronounced at the boundary. As a company on a roll emerges from small-cap status, its further growth gets counted as mid-cap growth. Yet when the same company's growth falters or declines, it can return to small-cap status, thereby reducing the performance of the small-cap Index. The same company can go back and forth across this boundary several times. Some research indicates that this boundary bias has a much greater effect on Index performance than commonly supposed.

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