Introduction
Small-cap value investing is a strategy that focuses on companies with low market capitalizations that appear undervalued based on fundamental metrics. Historically, small-cap value stocks have delivered superior long-term returns compared to large-cap stocks, albeit with greater volatility. Fisher Investments, known for its data-driven and client-focused investment philosophy, incorporates a diversified approach that may include small-cap value stocks when suitable for clients’ objectives. In this article, I will explore small-cap value investing, Fisher Investments’ perspective, and key financial metrics used in stock selection.
What is Small-Cap Value Investing?
Small-cap value stocks are shares of companies with market capitalizations typically ranging from $300 million to $2 billion. These stocks are considered undervalued based on financial ratios such as Price-to-Earnings (P/E) and Price-to-Book (P/B). Small-cap value investing is appealing because:
- These stocks often experience faster growth than large-cap stocks.
- They are more likely to be overlooked by institutional investors, leading to potential mispricings.
- Historically, they have provided higher risk-adjusted returns over long periods.
The expected return for a small-cap value investment can be modeled using the Capital Asset Pricing Model (CAPM):
E(R) = R_f + \beta (R_m - R_f)where:
- E(R) = Expected return of the stock
- R_f = Risk-free rate
- β= Beta coefficient (measure of volatility relative to the market)
- R_m = Expected market return
Fisher Investments’ Approach to Small-Cap Value
Fisher Investments does not exclusively market a “small-cap value” strategy but considers it within a broader portfolio context. The firm’s investment approach prioritizes:
- Global diversification to reduce concentration risk.
- Macroeconomic analysis to identify sectors likely to outperform.
- Fundamental research to find mispriced assets.
When small-cap value stocks align with a client’s risk tolerance and investment goals, Fisher Investments may include them in a diversified portfolio.
Key Metrics for Small-Cap Value Stock Selection
Investors use various financial metrics to evaluate small-cap value stocks:
- Price-to-Earnings (P/E) Ratio: Measures how much investors are willing to pay per dollar of earnings.
Price-to-Book (P/B) Ratio: Compares a company’s market price to its book value.
P/B = \frac{Market\ Price\ per\ Share}{Book\ Value\ per\ Share}Return on Equity (ROE): Measures a company’s profitability relative to shareholder equity.
ROE = \frac{Net\ Income}{Shareholder\ Equity}Debt-to-Equity (D/E) Ratio: Assesses a company’s financial leverage.
D/E = \frac{Total\ Debt}{Shareholder\ Equity}Historical Performance of Small-Cap Value Stocks
Studies show that small-cap value stocks have outperformed other asset classes over long time horizons. According to data from Fama and French, the average annualized return of small-cap value stocks from 1926 to 2020 exceeded that of large-cap growth stocks.
| Asset Class | Annualized Return (%) |
|---|---|
| Small-Cap Value | 13.5 |
| Large-Cap Value | 10.5 |
| Small-Cap Growth | 9.2 |
| Large-Cap Growth | 8.5 |
This performance advantage is attributed to the value premium, which suggests that stocks trading at lower valuation multiples tend to outperform over time.
Risks and Considerations
While small-cap value stocks present compelling opportunities, they also come with risks:
- Higher volatility: These stocks tend to have larger price swings.
- Liquidity concerns: Lower trading volumes can make it harder to buy or sell shares.
- Economic sensitivity: Small-cap companies are more affected by economic downturns.
The risk-adjusted return of small-cap value stocks can be measured using the Sharpe Ratio:
Sharpe\ Ratio = \frac{E(R) - R_f}{\sigma}where:
- E(R) = Expected portfolio return
- R_f = Risk-free rate
- σ = Standard deviation of portfolio returns
A higher Sharpe Ratio indicates a better risk-adjusted return.
Conclusion
Small-cap value investing has historically been a rewarding strategy for long-term investors willing to endure volatility. While Fisher Investments does not focus exclusively on small-cap value, it incorporates these stocks into client portfolios when appropriate. By focusing on data-driven analysis, fundamental metrics, and global diversification, the firm helps investors navigate the complexities of small-cap value investing. Investors considering small-cap value stocks should maintain a long-term perspective and ensure their portfolios align with their risk tolerance and financial goals.
