Draft Picks and Value Stocks
During the National Football League’s recent draft, teams selected from hundreds of prospects to build rosters for the future. It’s my favorite sporting event of the year, mainly because it provides an opportunity to see professional evaluators miss wildly with their projections.1 And while many sources of uncertainty contribute to these misses, NFL teams are often derailed by a self-inflicted error: focusing too much on a prospect’s weaknesses at the expense of all their strengths.
I was thinking about this lesson in the context of small cap value performance. Many investors have expressed concern over small cap value stocks underperforming large caps in the US over the 20 years ending in January. But this was largely an outlier from a global perspective. In major non-US markets, small cap value stocks handily outperformed their large cap counterparts over this period. While a two-decade stretch of underperformance is not what investors hope to see from US small value, it’s important to take notice of what went right for small value over this period.
20-year annualized return differences between small cap value stocks and large cap stocks
As of January 31, 2024
Past performance is not a guarantee of future results.
Thinking globally also reinforces the importance of diversification when emphasizing small cap value stocks. The returns for these stocks may not move in lockstep across regions, and outperformance for non-US stocks can mitigate the impact of disappointing relative returns in the US.
Footnotes
- 1. This is probably why I enjoy working in finance as well.
This article originally appeared in Above the Fray, a weekly newsletter for Dimensional clients.
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The Dimensional indices have been retrospectively calculated by Dimensional Fund Advisors LP and did not exist prior to their index inception dates. Accordingly, results shown during the periods prior to each index’s index inception date do not represent actual returns of the index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.
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Dimensional US Small Cap Value Index was created by Dimensional in March 2007 and is compiled by Dimensional. It represents a market-capitalization-weighted index of securities of the smallest US companies whose market capitalization falls in the lowest 8% of the total market capitalization and whose relative price is in the bottom 35% of the eligible market, or 25% prior to January 1975, after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The eligible market is composed of securities of US companies traded on the NYSE, NYSE American, and Nasdaq Global Market. Exclusions: non-US companies, REITs, UITs, and investment companies. From January 1975, the index excludes companies with the lowest profitability and highest relative price within the small cap universe. The index also excludes those companies with the highest asset growth within the small cap universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Source: CRSP and Compustat. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in December 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional International Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Exclusions: REITs and Investment Companies. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalization conditional on the securities being in the bottom 10% of market capitalization, excluding the bottom 1%. All securities are market capitalization weighted. Each country is capped at 50%. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Emerging Markets Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Maximum index weight of any one company is capped at 5%. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Europe Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Dimensional UK Small Value Index and Dimensional Europe ex UK Small Value Index combined using small value country weights. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Asia Pacific Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalization conditional on the securities being in the bottom 10% of market capitalization, excluding the bottom 1%. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Canada Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies whose relative price is in the bottom 35% of constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
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