SMALL CAP STOCKS

For eight years, between 1975 to 1982, these stocks had an average increase of 34.8% annually. Unbelievable- and that might be the problem. This surge was primarily responsible for most of the articles showing that small cap stocks have historically outproduced other large cap stocks over time- 12.6% vs 10.7% since 1926. (Large caps rose only 14.9%). But when you take out that surge, small caps have actually underperformed other markets. They have lagged the market since 1981, earning 14.4% versus 16.8% for the S&P 500. Yet in the 1990 though 1993, they returned no lower than 21%. In the same period, the S&P had only one double digit year in 1990 at 30.6%. But from then big stocks have outdistanced the S&P by an almost 3%. (23.1% vs 17.6%).

They also tend to be more volatile. When large caps declined in 1973 by 14.7%, small caps dropped 30.9%. In 1987, large caps dropped 21.5% but small caps went down 29.2%.

My use of small caps has taken a different bent during the last year due to these new reports, though they still do represent good diversification. However my primary focus might be in MINI cap stocks- the smallest of the small cap stocks. I think there is more opportunity there

SMALL CAP STOCKS (1997) Literally every article on investing focuses on the higher returns of small cap stocks. But a Professor Siegel of Wharton School said that the exceedingly high returns of small caps between 1974 and 1983 (35% annually) were an anomaly. Once those return were excluded, the returns for small caps actually were LOWER than large caps since 1926. Siegel noted that the returns for large cap stocks in the 80's were hurt by oil price increases, inflation and recession.

SMALL CAP ILLIQUIDITY: 1998 (Michael Brush) Many smaller stocks are sold on NASDAQ-National Association of Security Dealers Automatic Quotation system. It essentially is a computer listing of bid and asked prices by firms called market makers. A firm making a market in a stock must agree to buy and sell a certain amount of shares at the price they quote. But they are not forced into any transaction beyond the shares they indicate-say several thousand. Therefore, if selling pressure gets too great, the price too low, whatever, they can simply walk away and buyers/sellers are then forced into uncompetitive transactions. The issue became a significant problem after 1996 when the SEC imposed rules to keep the bid and asked prices narrower. This obviously reduced profits- which therefore reduced the number of market makers per stock. As a result, the market for the stocks is, according to one analyst, "very thin and illiquid. The market makers are not supporting the small stocks. The result is that prices can plunge when a large investor-say a mutual fund-tries to sell even a relatively small position in a stock."

NASDAQ currently has 5,487 stock listings.

CONTRARIAN INVESTING AND SMALL CAP STOCKS: (1999) (NY Times) " Consider the performance of the Dimensional Fund Advisors 9-10 Small Co. fund, the index fund that most closely follows the methodology of the academic studies. It invests in the 20 percent of New York Stock Exchange stocks with the smallest market capitalizations, as well as companies of similar size on the American Stock Exchange and NASDAQ; such companies, on average, are much smaller than those in the typical small-cap fund. DFA 9-10 Small Co. produced a 10.7 percent annualized return over the last 15 years, through Nov. 30, according to Lipper Inc., versus 17.2 percent for the Vanguard Index 500, which tracks the Standard & Poor's 500-stock index, a large-cap benchmark."

The Times article also noted that the costs of trading small caps was far greater than large cap stocks. A Wharton professor  "found that total trading costs for the buying and selling of the smallest stocks were sometimes more than 7 percent. For the largest stocks, by contrast, they were about one-half of 1 percent."

They also related to the Gompers and Metrick study noted herein-"the increasing institutional dominance of the market has led to enormous stock market share being shifted from small caps into large caps.

DELISTING: (1999) This is why the returns on small cap stocks are not necessarily valid. The companies may simply not be there to be counted. How's that?? In October 1998, 564 companies had already been delisted from the Nasdaq market that year because their price drooped under $1.00 per share. In an attempt to boost the quality of its issuers, stocks that fall under $1 for 30 days or more are subject to delisting. At the beginning of 1998, about 226 Nasdaq stocks, or 4.1% of the 5,500 on the market, were under $1. Now about 600 Nasdaq stocks, or 10% of the total market, trade under $1. "That's more than the annual totals in many years and is on track to eventually eclipse last year's total of 717 deletions and the record of 719 in 1988."