Investing in shares can, if done right, deliver unparalleled returns. But unless an investor has a specific stock on which they are focused, another question must be asked before specific choices are made. Is it better to invest in shares with a large or small capitalization?
Large-cap is the widely used national language for companies whose shares have large market capitalizations, meaning that valuations are higher than $ 10 billion. Small caps are the exact opposite: companies with a smaller market capitalization, often valued at up to $ 2 billion.
Both types of shares have their own benchmark indices. Large caps are mentioned on the well viewed, while the small cap index of choice is the one. The median market capitalization for companies listed on the S&P 500 is $ 22 billion, while companies listed on the Russell 2000 have a median market capitalization of $ 800 million.
Apple (NASDAQ :), Microsoft (NASDAQ :), and Amazon (NASDAQ :), all of which are listed on the S & P, each have a valuation value of $ 1 trillion, gathering significant investor and media attention . Conversely, you may never have heard of The Trade Desk (NASDAQ 🙂 Cree Inc (NASDAQ 🙂 and Coupa Software (NASDAQ :), three of the largest Russell 2000 components.
In the past ten years, it has become the conventional wisdom that small caps usually outperform large caps. But do they really do it? This is what we discovered from the data below, which gives an overview of the total annual return (including dividends) of both the S & P 500 and Russell 2000.
Russell 2000 versus S & P 500
First, based on the results of the last 40 years – the time frame for which the Russell 2000 data were available – the small-cap index performed 22 times better than the S&P 500; the S & P beat the Russell 18 different times. All in all, it therefore seems to be reasonably balanced.
Second: outperformance appears to be cyclical. The data show that the Russell generally outperformed between 1979-1983, 1991-1993, 2000-2014, while the S&P outperformed between 1984-1990, 1994-1999 and 2014-2018. By breaking through these periods a pattern is created.
The Russell 2000 outperformance coincides with economically difficult times in the US:
1979-1983: double-digit inflation, plus during 1980 and 1982 recessions.
1991-1993: 1990-1991 recession
2000-2014: Tech soap bubble, subprime crisis
The S & P 500 performed better than when the US economy was strong:
1984-1990: boom in 1980, leading to the 1990 recession
1994-1999: economic expansion in the mid 90s, leading to the tech bubble
2014-2018: Economic expansion after recovery from the 2008 crisis
Of course, the correlation between the performance of the indices is not absolute. For several years the results are not in contradiction with this theory. Yet the correlation is strong enough to indicate that when the economy expands, it is large caps. However, when economic conditions become difficult, go with small caps.
And since we have already cracked the figures, here is the answer to a likely secondary question: if you had invested $ 100 dollars in both the Russell and the S & P in January 1979, which investment would have yielded more money
In January 2019, our last data point, you would have seen a refund of $ 6,759 from the Russell, $ 7,835 for the S & P. ​​But the return flow was also time dependent. The Russell took the lead from the start of the period under review until 1989. In 1989, the S & P took over until 2010.
The strong recovery of the Russell 2000 after the tech bubble and subprime crisis allowed it to regain its overall lead in 2010, only to waste it in 2014, when the S & P roared back to dominance, where it was until to this day.
