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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: Bob Rudd who wrote (695)	8/29/1998 11:13:00 AM
From: porcupine --''''>	Read Replies (1) \| Respond to 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.

To: Bob Rudd who wrote (695)	8/29/1998 4:49:00 PM
From: Boyd Hinds	Read Replies (1) \| Respond to of 1722

Thanks Bob for your insights. My comments: Small caps often do relatively better in inflationary times since they are often the marginal producers. During lean times they get table scraps, but when demand exceeds supply, these marginal players can earn excess profits that has greater impact due to small size. That assumes that small caps can't earn the same kinds of margins that the large caps do. In some cases where a company has carved out a niche for itself, it can grow its sales and maintain margins quite nicely. Sometimes the barriers to entry keep other companies out, or perhaps the size of the market is just not big enough to make it worth their while. Either way, some small caps can do very well in a difficult growth environment. Anyway, if I'm buying widgets (or some other commodity) and I can get them at a cheaper price from a smaller and reputable dealer, why wouldn't I go with the smaller company?? The relative underperformance today appears to be more driven by liquidity issues. I agree 100%. The funds that are the defacto allocators of capital are concerned about roach motel affect of small caps [Can't get out in selloff] and since they are driven by quarterly performance, they tend to gravitate to the momentum issues - that's not small caps. Ah, the mutual fund industry. I think institutions have a big herd mentality and they are feeling pretty worried about a repeat of the "Nifty 50" meltdown of the 1970s. Look at all the fundamental valuations: they all favor the micro and small caps. I have read study after study that says small stocks are selling at discounts to the large caps that haven't been seen since 1990. If Wall Street doesn't understand good value, I think the individual investor will. IMHO, the individual investor will come to the rescue of the small cap market. I think more and more individuals are managing their own portfolios, and with access to the Internet, the information available is as good as any fund manager or analyst gets. Yes the risks of small caps are much higher, but so are the rewards. The reward to risk ratio has been growing tremendously over the past three years in favor of the small caps. At some point they will outperform. And once they do, all the "momentum" players will happily jump on board.