Little Dynamos: Funds That Get Big Returns From Small-Cap Stocks
NEW YORK ( TheStreet ) -- Small stocks have led the markets in recent years. During the past decade, small blend funds returned 9% annually, compared to 6.9% for large blend, according to Morningstar.
Will small stocks win in the next ten years? Probably not. Valuations are too rich. According to Morningstar analyst Alex Bryan, the small stocks of the Russell 2000 index have a forward price-to-earnings ratio of 19.7, compared to 16.2 for the large-cap Russell 1000 benchmark. When small stocks sell at such premiums, they rarely go on to lead in coming years, says Bryan. In 2004, the Russell 2000 sold for a multiple of 16.9, compared to 18.6 for the Russell 1000. The discounted small stocks went on to dominate the markets.
To avoid the priciest small stocks, consider small value funds, which have an average multiple of 16. Some top small value funds have shown that they can deliver consistent results by spotting promising companies selling at big discounts. Solid funds include Huber Capital Small Cap Value
To diversify large-cap portfolios, consider adding Perritt Ultra MicroCap. While the stocks of the S&P 500 have an average market capitalization of $66 billion, Perritt's market cap is $78 million -- the lowest of any U.S. equity fund tracked by Morningstar. Most portfolio managers shun tiny stocks because they can be risky and hard to trade. But unloved microcaps have a history of delivering outsized returns, according to Dartmouth professor Kenneth French. From January 1982 through November 2013, microcap value stocks returned 16.4% annually, compared to 11.6% for large cap value.
Perritt seeks to find up-and-coming stocks that have not yet been discovered by Wall Street. During the past five years, the fund returned 27.3% annually, outdoing 92% of small value funds. A holding is USA Technologies
Corbett also likes Vapor (VPCO) , a supplier of electronic cigarettes. The company's brands have been growing rapidly as more consumers seek alternatives to tobacco.
During the past five years, Huber Capital Small Cap Value returned 33.6% annually, ranking as the top-performing small value fund. Portfolio manager Joseph Huber looks for stocks that are depressed below historic levels because the businesses are performing poorly. The aim is to find companies with managers that are poised to improve profits back to normal levels. Huber prefers companies with competitive advantages and decent balance sheets.
A holding is CNO Financial