Quality in Small versus Large-Cap Stocks
Quality stocks outperform, right?
December 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Adding quality filters significantly improves small-cap investing
- However, the opposite occurs in the large-cap space
- Likely explained by more lower-quality companies in the small-cap space
INTRODUCTION
In the biblical fight between David and Goliath, most people favor David. Betting on the small guy to overcome power and adversity is universally appealing. However, in the stock market, David has been losing the fight as the size factor generated negative returns in 18 out of 21 stock markets over the last 30 years (read The Illusion of the Small-Cap Premium).
Intuitively, small-cap stocks should have outperformed large-cap stocks as small companies are riskier than large companies, but they have not. Naturally, investors can reduce the risk of small-caps by introducing quality filters, which may make small-cap investing attractive.
In this research article, we will compare small versus large-cap quality stocks.
SMALL-CAP QUALITY STOCKS
One of the popular charts of 2024 is the outperformance of the S&P Small Cap 600 versus the Russell Index 2000 Index. Both indices provide exposure to U.S. small-cap stocks, but the S&P index requires companies to have positive earnings over the last four quarters. This simple filter has led to a significant outperformance compared to the Russell 2000 Index since 2000.
