Small cap stocks: How are they faring?

I’ve been working away on the latest edition of the MoneySense Small Cap 100, which is devoted to small U.S. stocks. It reveals the best pint-sized firms using the same methodology as the Top 200 and Top 500. Keep an eye out for it in the next issue of the magazine.

I’m pleased to say that last year’s small-cap All Stars outperformed the market handily. But it was a bad year for stocks generally and for small stocks in particular.

The Small Cap 100 uses a database of U.S. firms that have annual revenues of $200 million or more. As of the second week of February, the average stock in the database had declined by 19.3% over the prior 12 months, including reinvested dividends. Stocks with market capitalizations of less than $2 billion suffered from an average loss of 25.4%. Firms under $1 billion were down by 29.5% on average. That’s a whole bunch of red ink.

During trying times it’s useful to take a step back to get a little historical perspective. For some numbers I turn to data collected by Professor Kenneth French. In one study he split the U.S. stock market into three groups by market capitalization. Each group was tracked for a year and then the process was repeated.  In this way he was able to determine the performance of the three groups over time.

I plotted drawdowns for the large and small groups in the following graph. The monthly data starts in 1966 and goes to the end of January 2016. (The middle group was omitted because the graph is complicated enough without it.)

You’ll immediately notice that stocks rarely make new highs and instead spend most of their time below them. (Nonetheless, the market has done very well over the long-term.)

It is also obvious that small stocks tend to suffer more than large stocks during downturns.  (The Internet bubble was an exception.) Declines of 20% are relatively common for small stocks and they have fallen to about 40% of their former highs on a couple of occasions since the 1960s.

For stock market horror you have to go back to the crash of 1929 when small stocks tumbled to 9% of their former highs, including reinvested dividends. Gulp! Mind you, investors who held on profited handsomely over the years.

Those who are willing to take a walk on the wild side should pick up a copy of next month’s magazine to learn about the new crop of top small stocks.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of February 22. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.

Source: Bloomberg, February 22, 2016

Notes

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

Frugal Finance

The Cost Matters Hypothesis

“We need only the CMH. Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur.” – Jack Bogle