Small stocks can add up to big gains
5 reasons they should be part of your portfolio
If there aren’t any small stocks in your investment portfolio or 401(k), you’re missing out on big gains.
While big stocks such as Apple and big indexes such as the Dow Jones industrial average get most of the attention from investors, it’s the shares of little companies without big reputations that are the huge performers this year.
Never heard of satellite service firm Intelsat, nursing-home provider Genesis Healthcare and taser-maker Axon Enterprise? These off-the-radar companies are just a few of the winners in the Russell 2000 index — which includes stocks of smaller companies with an average market value of
$2.5 billion. The index reached a record high Wednesday and is up more than 9% this year. That compares with a gain of less than 4% for the Standard & Poor’s 500 index, which includes giants such as Apple, whose market value is nearly $1 trillion.
The better performance of smaller stocks in 2018 follows a tough 2017, when their returns trailed big stocks by more than six percentage points. The change in fortune is a reminder to investors that devoting a portion of their portfolio to tiny companies is a good way to spread around their holdings, potentially smoothing out bumps when one part of their portfolio dives lower. Plus, the little companies that no ones knows could one day grow into big blue-chip powerhouses such as Facebook or Coca-Cola.
In fact, small stocks posted compound annual returns of 12.1% from
1926 to 2017, which is better than the
10.2% gain of large stocks in the 92year period, according to the 2018 Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook. $1 invested in small stocks at the start of 1926 grew to
$36,929 by the end of 2017, compared with $7,353 for large-company stocks, according to the SBBI Yearbook.
Here are five big reasons why smallcompany stocks should be a part of your investment portfolio:
1. Boosts diversification
The more your money is placed in different types of investment and assets — such as large stocks or small ones, domestic stocks or foreign equities, bonds or real estate — the less risky your portfolio becomes. It also boosts your odds of owning something that is rising in value, which helps offset weakness or losses in other parts of your portfolio. Small-company stocks also have a history of posting better returns than other investments over the long term, especially the closely followed S&P 500.
“Over a longtime horizon — five
years, 10 years, 20 years, pick a number — the Russell 2000 has performed better,” says Arun Daniel, a portfolio manager specializing in small and midsized stocks at JO Hambro Capital Management in Boston.
2. Limits exposure to foreign turmoil
The negative fallout of global trade conflicts and tariffs is more an issue for big companies that do a lot of business abroad. Small companies only get about
10% to 20% of their sales from overseas vs. more than
43% for S&P 500 companies.
That U.S.-centric business model insulates small American companies from overseas problems. What’s more, troubles abroad, such as the political uncertainty in Italy and Spain, can hurt earnings in places such as Europe, making the strong earnings power of small U.S. firms in a faster-growing U.S. economy more appealing.
Commercial Metals, a Texas-based company that manufactures, recycles and markets steel and metal products, is expected to see demand for their products go up if U.S. tariffs result in less foreign steel imports, Clark Hodges of money management firm Hodges Capital Management in Dallas says.
3. Benefits from Trump tax cuts
President Trump’s record-size tax cuts to corporations was designed to benefit American companies, and U.S.-based firms that get the bulk of their sales at home were big beneficiaries. In general, every dollar that doesn’t go to paying taxes goes straight to the bottom line.
“The tax rate for small companies is about 5% higher than larger companies, so the tax reform passed in late 2017 will continue to be a major tailwind,” says Ryan Detrick, senior market strategist at LPL Financial.
4. Skirts strong dollar
Since the market low in February, the U.S. dollar has risen 5.4% vs. a basket of foreign currencies, due mainly to rising interest rates in the U.S. and weaker growth abroad. While a rising buck is good for tourists, as their dollars will have more purchasing power overseas, its crimps sales for big U.S. companies whose products become more expensive for foreign buyers paying with weaker currencies.
Smaller, domestically focused companies suffer far less from the currency hit because they sell the bulk of their products and services in the U.S.
5. Sets up investors to ride rally
The Russell 2000’s ability to break out to record highs, while the large-cap S&P 500 still sits more than 3% below its peak, bodes well for the small stock market leadership to persist, says Ari Wald, an analyst at Oppenheimer & Co. in New York.
“Small caps have had a nice run, and that’s showing up on traders’ radar,” Wald says, adding that the climb to new highs is a “sign of buying demand.”