Interestingly, small-cap stocks have seen such a move previously exceeded their larger counterparts, and if the lecturers are to be believed, this may proceed to be the case in the long run. Don’t let the news affect you; The dominance of mega-cap stocks over the past decade is not the entire story.
What is market capitalization?
Market capitalization, short for market capitalization, is the whole market value of an organization’s outstanding stocks or shares. To calculate market capitalization, multiply the variety of shares by a share’s market price. (For example, an organization with 10 million shares priced at $25 each has a market cap of $250 million.) People within the investing community use market cap to point the worth of an organization and its size relative to others in the identical industry or sector. Exchanges and cryptocurrencies even have a market capitalization.
When it involves the stock market, there are specific formulas called asset pricing models that help us understand why stocks move the way in which they do. You could have heard of a model called CAPM (Capital Asset Pricing Model). Basically, CAPM tells us that the return you’ll be able to expect from a stock relies on how dangerous it’s in comparison with the general market. That’s like saying the riskier the stock, the greater the potential return must be.
Here’s the kicker: CAPM doesn’t reveal the entire story. This ignores another aspects that may impact a stock’s performance. Back within the Nineteen Nineties, two University of Chicago professors, Eugene Fama and Kenneth French, added further layers to this model. It’s called the Fama-French three-factor model. This later evolved right into a five-factor model, but to maintain it easy we’ll persist with the unique three:
- Market factor (Rm-Rf): This is the extra return you’ll expect from investing within the stock market over something super secure like government bonds.
- Size factor (SMB for Small minus Big): This is interesting since it shows that smaller corporations often outperform larger corporations. It’s like rooting for the underdog.
- Value factor (HML for High Minus Low): This shows us that stocks whose price is lower relative to their book value (think bargain stocks) often perform higher than those which can be dearer.
So specializing in the scale factor explains why these smaller corporations, or “small caps” as we call them, may produce higher returns over time than the giants of the stock world.
To understand the performance dynamics between large- and small-cap stocks, we are able to examine two older index-based U.S. mutual funds: the Vanguard 500 Index Fund Admiral Shares (VFIAX), which tracks the S&P 500, and the Vanguard Small-Cap Index fund -Admiral Stock (VSMAX).
We use a backtest period from November 14, 2000 to September 19, 2024. This timeline is especially informative since it includes several major market events: the dot-com bust, the 2008 financial crisis, the COVID-19 pandemic, and the one which followed Bull market driven primarily by technology stocks.
During this era, small caps represented by VSMAX outperformed the S&P 500 tracked by VFIAX. The compound annual growth rate (CAGR) for VSMAX was 9.21% in comparison with 7.98% for VFIAX. However, this higher return got here with increased volatility and bigger drawdowns (price declines from peak to trough).
On a risk-adjusted basis, each funds’ performance essentially leveled off at the same Sharpe ratio of 0.31, meaning investors in VSMAX were kind of fairly compensated for the upper risk related to small-cap investing.
