Small Cap Value [How to analyze a small sample size?]

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Clive
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Small Cap Value [How to analyze a small sample size?]

Post by Clive »

Running my own screen for small cap value in a manner broadly similar to Kenneth French's Small cap value filter http://mba.tuck.dartmouth.edu/pages/fac ... olios.html my somewhat crude filter produced fewer stocks than French's more recent SCV set, perhaps because I used a free yahoo based filter which might not have as complete data as used by French. At recent levels my SCV filter set yielded candidates that broadly had market cap (MC) < $500M and Price to Book Value (P/BV) <1.0 characteristics.

Of that set, average MC = $142M, average P/BV = 0.56 (French prefers to use the inverse choice of high book to price measure over that of using low P/BV).

Which is a bit like applying a Ben Graham filter of buying stocks with per share book value greater than the share price - but applied to small companies rather than the large well established companies that Graham preferred (larger companies don't tend to have the same level of good-value qualities in more recent times that were available in Ben Graham's time).

Graham's filter of buying companies at 50c on the $1 has the protection qualities that he liked. Good valued small companies can also be taken over (absorbed by larger companies) relatively easily, or grow relatively quickly, perhaps in a non correlated manner to the wider market in general.

My question is whether anyone is aware of discussion groups/boards that specifically evaluate/target such stocks individually? Perhaps looking to DIY a subset 30 to 50 stocks out of 300+ potential candidates (2% to 3% individual stock risk)? My thoughts are that if the wider set of SCV on average can achieve above average longer term results, then filtered subsets selected from that wider set have the potential to improve results further.
larryswedroe
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Re: Small Cap Value [How to analyze a small sample size?]

Post by larryswedroe »

read the new book quantitative value

Larry
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Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

Thanks Larry.
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Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

From this review http://blogs.cfainstitute.org/investor/ ... ive-value/ a debt-to-equity ratio less than 50% isn't always a good choice. Whilst relatively low debt can be a safer choice (many company failures arise out of bad debt management), a higher debt ratio at times can be beneficial (as can other forms of having borrowed to invest - 50% in a 2x leveraged ETF instead of 100% in the 1x underlying for instance).

Historically there have been instances of treasury yields being suppressed, during which times inflation has spiked into double digits for sequential years during such suppressed treasury yields years.

Treasury yields were kept low either by government policy - such as publicising an intent that treasuries would be bought in sufficient quantity to keep yields low (steering the market to self adjust to low yields), or by actually buying treasuries in sufficient quantity to keep yields low (along the lines of recent Bank of England, US Fed etc. Quantitative Easing). Lenders - such as buying treasuries relatively lose out, borrowers relatively win during such phases. That's a useful diversification to have during such periods as many/most of the alternatives might suffer during such phases.
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mlewis
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Re: Small Cap Value [How to analyze a small sample size?]

Post by mlewis »

If you don't own them all you risk missing out on the big winners.

http://www.efficientfrontier.com/ef/900/15st.htm

malcolm
saurabhec
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Re: Small Cap Value [How to analyze a small sample size?]

Post by saurabhec »

mlewis wrote:If you don't own them all you risk missing out on the big winners.

http://www.efficientfrontier.com/ef/900/15st.htm

malcolm
Funny how the Dow keeps tracking the large cap market with just 30 stocks out of a potential universe of 1,000 large cap stocks.
Topic Author
Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

mlewis wrote:If you don't own them all you risk missing out on the big winners.

http://www.efficientfrontier.com/ef/900/15st.htm

malcolm
The more stocks you hold the less impact a single big winner will have on the whole (assuming equal weighted). Whilst the best performer out of a fewer number might not be such an outstanding winner, when that relatively smaller big gain is shared across a fewer total number of stocks the overall benefit might be much the same as had a larger number of stocks been held and the best performer was a much higher gain.

As in how bond defaults are a factor in assessing bond risk/reward, for example perhaps Treasury bonds yielding 4% whilst corporate bonds yield 6% but have a 2% default risk, the same also holds for stocks. Based on Kenneth French's data since 1926, the chance of a small cap value stock not still being listed a year later is higher than for large cap.

For each of Small and Large cap, Growth, Blend and Value

Code: Select all

One Year Survivorship 1927 - 2013			
			
     Average    Min     Stdev

LCG	98.32%	93.28%	1.71%
LCV	97.90%	89.27%	2.42%
LCB	97.62%	90.08%	2.39%
SCB	95.73%	86.73%	3.41%
SCG	95.34%	85.67%	3.67%
SCV	94.54%	83.92%	4.17%
Using William Bernstein's data from http://www.bogleheads.org/wiki/Historic ... ed_Returns large stocks had around a 4% expected real return whilst small cap value had a 7% real expectation. From above, large had around a 2% average default rate (stock not being in set after a year), whilst Small Cap Value had a 5.5% average default rate.

Large Cap : 4% expected - 2% default = 2%
Small Cap Value : 7% expected - 5.5% default = 1.5%

i.e. broadly similar outcomes give or take some rounding and other noise.

What that above data doesn't say however, is what actually happened for the stocks that did drop out of the set before a year had passed. If the drop-out was due to being taken over/absorbed, then the 'default' isn't necessarily a loss of capital value (it could even have been a sizeable capital gain). If the drop out was due to collapse/bankruptcy then there was a capital loss. For stocks with price to book value of <1.0 (perhaps 0.5 average) as per small cap value stocks, its perhaps more likely to be the former rather than the latter as in concept the assets (book value) can be broken up and sold off for more than the price paid for the stock.

Whilst small cap growth have slightly fewer 'defaults' than small cap value, the loss associated with each default in SCG might be total whereas for SCV there may be little/no loss associated with each default.
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Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

Here's a purely arbitrary example of a small cap value filtered stock using http://screener.finance.yahoo.com/newscreener.html and looking for criteria of

Market Cap <=500m
Price Book Ratio <=1
Return on Equity >=10
P/E <=10
Total Debt/Equity <=1.0

One of the stocks presented from that filter was Emerson Radio Corp. (MSN (NYSE:MKT))

Market Cap $43M
Price to Book 0.92
PE 4.4
Return on Asset 10.2
Return on Equity 21.1
Debt/Equity 0.26

So broadly likely to be included in a Small Cap Value index set.

Dig a little deeper however and there was a sharp drop in share price in October 2012

Image

and delving deeper http://biz.yahoo.com/e/130214/msn10-q.html that looks to have been caused by (my highlights) :

As reported by the Company in a Form 8-K filed with the SEC on October 19, 2012, the Company has been informed by its customer Wal-Mart, which accounted for approximately 48% of the Company's net revenues during the year ended March 31, 2012 ("Fiscal 2012"), that, commencing with the Spring of 2013, it will discontinue purchasing from Emerson two microwave oven products currently sold by the Company to Wal-Mart. During Fiscal 2012, these two microwave oven products comprised, in the aggregate, approximately $48.4 million, or 31%, of the Company's net product sales. Currently, it is anticipated that Emerson will continue shipping these products throughout the remainder of Fiscal 2013 (the year ending March 31, 2013), with sales of such products declining through the fourth quarter of Fiscal 2013. Emerson anticipates that the full impact of Wal-Mart's decision will be realized by the Company in Fiscal 2014, which begins on April 1, 2013. As previously disclosed by the Company, the complete loss of, or significant reduction in, business with either of the Company's key customers will have a material adverse effect on the Company's business and results of operations. Accordingly, Wal-Mart's decision will have a material adverse effect on the Company's business and results of operations. The Company is considering various strategic initiatives, including a complete analysis of its current and prospective product lines and pricing strategies. There can be no assurance that the Company will be able to increase sales of such products at levels sufficient to offset the adverse impact of Wal-Mart's decision, if at all.

Looking at the slightly longer term historic

Image

provides a feel for how the share price could span a 10-fold range (by eye I see an approximate 0.5 low and a 5.0 high during that 5 year period).

MSN is too small for the big players to even bother analyse. Instead they might just include it in a small cap value set based on simple measures alone, perhaps size - measured as market cap and value measured by its price to book (book-value). Whereas a little additional research might highlight specific warnings (stay clear) or potentials (buy). I'd guess that any such additional selectivity could be more productive overall compared to the simpler filter-and-buy approach, and is one area in which perhaps a private individual investor could be on a more level playing field with larger investment groups. For the average individual investor wading through perhaps 300+ potential candidates to filter out maybe 20 or 30 however is still a considerable effort - and one that would be better served by a small syndicate of such investors sharing such analysis/selection effort. Whether that might be productive enough to generate sufficient alpha to warrant such effort over that of holding a more broader (simple filter) set ??? My guess is that it could, but I have no data with which to back that up.
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Blue
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Blue »

Why would you want to do this? I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.

Holding individual stocks increases the likelihood of not holding the few stocks that drive the risk premia.
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Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.

Holding individual stocks increases the likelihood of not holding the few stocks that drive the risk premia.
Thanks Blue. I wasn't aware of that characteristic.
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mlewis
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Re: Small Cap Value [How to analyze a small sample size?]

Post by mlewis »

Clive wrote: The more stocks you hold the less impact a single big winner will have on the whole (assuming equal weighted). Whilst the best performer out of a fewer number might not be such an outstanding winner, when that relatively smaller big gain is shared across a fewer total number of stocks the overall benefit might be much the same as had a larger number of stocks been held and the best performer was a much higher gain.

Well, it might be. If you buy a single lottery ticket and win, you will win money with less expenditure then if you bought 100 tickets and won. Do you want to gamble or do you want to retire? Owning more stocks decreases the changes of winning big, but increases the chances of not losing.

As you like it

malcolm
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Re: Small Cap Value [How to analyze a small sample size?]

Post by stlutz »

I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.
Does anyone have a citation for this? I know it gets said here periodically (I've repeated it myself), but I actually don't have a reference.

Thanks.
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Blue
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Blue »

stlutz wrote:
I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.
Does anyone have a citation for this? I know it gets said here periodically (I've repeated it myself), but I actually don't have a reference.

Thanks.
Migration by Fama & French
Topic Author
Clive
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Re: Small Cap Value [How to analyze a small sample size?]

Post by Clive »

mlewis wrote:
Clive wrote: The more stocks you hold the less impact a single big winner will have on the whole (assuming equal weighted). Whilst the best performer out of a fewer number might not be such an outstanding winner, when that relatively smaller big gain is shared across a fewer total number of stocks the overall benefit might be much the same as had a larger number of stocks been held and the best performer was a much higher gain.
Well, it might be. If you buy a single lottery ticket and win, you will win money with less expenditure then if you bought 100 tickets and won. Do you want to gamble or do you want to retire? Owning more stocks decreases the changes of winning big, but increases the chances of not losing.
Buying every lottery ticket and your chances of winning are excellent.
Buy 25% of tickets and your chances of winning are good.
Overall on average the two might work out much the same over the longer term.
I appreciate that whilst a subset of all small cap value has as similar average benefit to that of holding the entire small cap value set, that the sub-set approach would be more volatile and as such for some could work out worse, better for others. If some additional filters (selectivity) is applied, potentially you're more likely to be in the latter (best) case. For instance the SCV effect I believe is fractal. Filter the SCV set by SCV measures and the smallest/deepest value yield more than the largest/least value. Or some other filtration methods - such as manual review of each stock and making a decision whether to include or exclude it from the held set.
Blue wrote:
stlutz wrote:
I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.
Does anyone have a citation for this? I know it gets said here periodically (I've repeated it myself), but I actually don't have a reference.
Migration by Fama & French
Thanks Blue

That indicates that the few big winners effect is mostly from the Small stock set. For Value the gains are more evenly distributed.

The size premium is due almost entirely to the extreme positive returns of small stocks that move to a big stock portfolio from one year to the next. Three factors contribute to the value premium. (i) Plus transitions, with their high returns, occur more often for value stocks than for growth stocks. (ii) Minus transitions and their low returns are more likely for growth stocks. (iii) Value stocks that remain in the Same portfolio from one year to the next have higher average returns than the matching (small or big) growth stocks.
flizzo
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Re: Small Cap Value [How to analyze a small sample size?]

Post by flizzo »

Clive wrote:
For each of Small and Large cap, Growth, Blend and Value

Code: Select all

One Year Survivorship 1927 - 2013			
			
     Average    Min     Stdev

LCG	98.32%	93.28%	1.71%
LCV	97.90%	89.27%	2.42%
LCB	97.62%	90.08%	2.39%
SCB	95.73%	86.73%	3.41%
SCG	95.34%	85.67%	3.67%
SCV	94.54%	83.92%	4.17%
Hello...where did you find this one-year survivorship data? Was this somewhere in French's Data Library? I couldn't find it here...

http://mba.tuck.dartmouth.edu/pages/fac ... brary.html

Thanks.
comeinvest
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Re: Small Cap Value [How to analyze a small sample size?]

Post by comeinvest »

Clive wrote:
mlewis wrote:
Clive wrote: The more stocks you hold the less impact a single big winner will have on the whole (assuming equal weighted). Whilst the best performer out of a fewer number might not be such an outstanding winner, when that relatively smaller big gain is shared across a fewer total number of stocks the overall benefit might be much the same as had a larger number of stocks been held and the best performer was a much higher gain.
Well, it might be. If you buy a single lottery ticket and win, you will win money with less expenditure then if you bought 100 tickets and won. Do you want to gamble or do you want to retire? Owning more stocks decreases the changes of winning big, but increases the chances of not losing.
Buying every lottery ticket and your chances of winning are excellent.
Buy 25% of tickets and your chances of winning are good.
Overall on average the two might work out much the same over the longer term.
I appreciate that whilst a subset of all small cap value has as similar average benefit to that of holding the entire small cap value set, that the sub-set approach would be more volatile and as such for some could work out worse, better for others. If some additional filters (selectivity) is applied, potentially you're more likely to be in the latter (best) case. For instance the SCV effect I believe is fractal. Filter the SCV set by SCV measures and the smallest/deepest value yield more than the largest/least value. Or some other filtration methods - such as manual review of each stock and making a decision whether to include or exclude it from the held set.
Blue wrote:
stlutz wrote:
I've always understood the small-value premium to be driven by a small percentage of "lottery tickets" within the larger group.
Does anyone have a citation for this? I know it gets said here periodically (I've repeated it myself), but I actually don't have a reference.
Migration by Fama & French
Thanks Blue

That indicates that the few big winners effect is mostly from the Small stock set. For Value the gains are more evenly distributed.

The size premium is due almost entirely to the extreme positive returns of small stocks that move to a big stock portfolio from one year to the next. Three factors contribute to the value premium. (i) Plus transitions, with their high returns, occur more often for value stocks than for growth stocks. (ii) Minus transitions and their low returns are more likely for growth stocks. (iii) Value stocks that remain in the Same portfolio from one year to the next have higher average returns than the matching (small or big) growth stocks.
I don't see how the cited paper ("Migration") implies that one has to buy the whole SV (small value) index to take advantage of the premium. On page 2/3, it says "In the end, the size premium in average returns for 1927-2006 traces almost 2 entirely to the high average excess returns (more than 50%) earned by the 8-12% of small stock market cap that moves to a big portfolio from one year to the next." Given this percentage, and assuming that it's not the same 8-12% of SV stocks that do the transition every year, I would conclude that with a 30-50 stock sample, one would have a high likelihood of capturing plenty of such transitions when holding the portfolio for several years.

I have yet to see a citation that leads to the conclusion that one has to buy the market or some DFA fund or similar, to capture "lottery tickets". Repeating it over and over on this forum doesn't make this conjecture true or give it more substance. Sorry for being "nonconforming" with repeat posters or the index and smart beta fund industries. Would be glad to see some actual backtested factual evidence, or theoretical foundation.
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