Trends in Small Cap Stock Returns

Although the historical return on small stocks has outpaced large stocks since 1926, the magnitude of the small-cap stock outperformance has waxed and waned unpredictably over the past 80 years. A comparison of the cumulative returns on small stocks with those of the S&P 500 Index is shown in Figure 9-1.9

Small stocks recovered smartly from their beating during the Great Depression, but they still underperformed large stocks from the end of World War II until almost 1960. In fact, the cumulative total return on small stocks (measured by the bottom quintile of market capitalization) did not overtake large stocks even once between 1926 and 1959. Even by the end of 1974, the average annual compound return on small stocks exceeded large stocks by only about 0.5 percent per year, not nearly enough to compensate most investors for their extra risk and trading costs.

But between 1975 and the end of 1983, small stocks exploded. During these years, small stocks averaged a 35.3 percent compound annual return, more than double the 15.7 percent return on large stocks. Cumulative returns in small stocks during these nine years exceeded 1,400 percent. Figure 9-1 shows that if the nine-year period from 1975 through

9 The small-cap stock index is the bottom quintile (20 percent) size of the NYSE stocks until 1981, then it is the performance of Dimensional Fund Advisors (DFA) Small Company fund from 1982 through 2000, and then it is the Russell 2000 Index from 2001 onward.

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