By John Wasik
CHICAGO, April 27 (Reuters) – Ugly duckling stocks are surprises in small packages that turn into great performing swans later on down the road. Nearly every large company started out as a “small cap,” which generally refers to a stock with under $1 billion in market capitalization. Most small companies do unsexy things such as make pumps or generic drugs. You’ll rarely hear them touted by big-name analysts or firms.
When business and economic cycles favor them, though, small caps soar relative to big-cap stocks, especially because they are usually priced at a bargain. Over the past three years through April 25, for example, the Vanguard S&P 500 Fund rose 19.4 percent. In contrast, the DFA US Small Cap Value fund climbed 22.7 percent (). Note: The DFA fund, representing an index of small companies, is only available through investment advisers.
Long-term, exhibiting what investment analysts call “the small company effect,” these pint-sized stocks produced a compound annual growth rate of almost 12 percent from 1925 through 2011, according to Ibbotson Associates’ 2012 Classic Yearbook (). That compares to about 10 percent for the S&P 500 index of large stocks, typically over $2 billion, and about 6 percent for long-term government bonds. Small caps are generally stocks from $300 million to $2 billion in market capitalization; mid-caps from $2 billion to $10 billion; and large caps from $10 billion on up. Much of the small-company/value effect has been documented by academics Kenneth French, Eugene Fama and Rolf Banz ().