- Size is significant. Small stocks have higher standard deviations than large stocks.
- Book value is significant. Stocks with low Price/Book ratios have higher returns than stocks with high Price/Book ratios.
- Adjusted for book value assets, the smaller the company and the lower the Price/Book value of equity assets, the greater the stock return.
- Earnings are significant. Stocks with low Price/Earnings ratio have higher returns than stocks with high Price/Earnings ratio.
- Only size and Price/Book are significant when the three factors are taken together. Price/Earnings is not meaningful.
We are able to analyze some of the above statements with more accuracy than others as to their "truth." I will concentrate on U.S. equities using available ETFs and 73 months of data. Unfortunately, I do not have 15 or 20 years of data for the critical ETFs, but we can pick up some trends. Take the first statement regarding size. Looking at value ETFs, VTV, VOE, and VBR, the standard deviations are 18.2%, 21.0% and 23% respectively. Yes, the SD increases as we move from large-cap to small-cap stocks. While the differences are not great, the trend is established.
Moving over to the growth side of the investing spectrum we have information on VUG (18.0%), VOT (21.8%), and VBK (23.3%). Once more, the standard deviations increase as we move from large to smaller cap stocks.
What about returns over the past 73 months. Here the data is not so clear. Beginning with the three value ETFs we have the following return results. VTV, VOE, and VBR returned 3.5%, 5.7%, and 5.8% respectively. Returns did increase as we move from large-cap to smaller cap stocks, following the SD trend. Turning to the three growth ETFs, VUG, VOT, and VBK, the returns are 7.8%, 7.2%, and 9.5% respectively. The trend is broken as we move from larger to smaller stocks. But even more important is the notion that value stocks (those with low Price/Book ratios) will perform better than growth stocks (those with higher Price/Book ratios). That well-known axiom, based on Fama-French research, did not hold up over the past 73 months. In each value-growth combination (VTV and VUG for example), growth stocks outperformed their value counterpart.
Small-Cap Value VBR holds companies with lower Price/Book ratios than does Small-Cap Growth VBK, yet VBK outperformed VBR by 3.7% (9.5% – 5.8%), not a trivial percentage. Is the last 73 month time frame an anomaly? Perhaps. The lesson to learn is that we should not eliminate growth stocks from the portfolio. We can either invest in VUG, VOT, and VBK directly or we can pick up growth stocks by holding VTI (which we do in all portfolios) or pull in growth holdings by including VO and VB, our mid-cap and small-cap blend ETFs.