Think Big, but Go With Small Caps

Since December 1999, shares of small-cap and mid-cap companies posted far superior total returns than mega-cap stocks. It was not by a small amount. Their returns were almost double that of their larger brethren. In fact, the S&P 500 as a whole did not get into the black permanently for almost 12 years after the tech and internet bubble burst. How did that happen? Big caps had run so hot from 1996 through 1999 that they became unrealistically expensive relative to all previous history. Tech names like Oracle and Cisco Systems were valued at over 100-times projected earnings. Even everyday non-tech names like Walmart and Home Depot commanded price-to-earnings of about 40 to 50. Those were triple to quadruple what they fetched just five to eight years earlier. The Nasdaq 100 was the most overpriced, just before things went south. Those shares went almost 20 years before finally showing positive inflation-adjusted returns. P/E expansion is so much fun when you're holding shares that surge exponentially. It's like getting high. Artificially inflated moods can't last forever, though, and typically end with crashes or hangovers. Late 2021 saw many of the same signs in large-cap names that were present back in 1999. Here are two widely held examples to illustrate what was had been going on. From 2011 through 2016, Apple was offered at extremely cheap valuations running from about 10-times to 13-times earnings. From 2013 - 2016 shareholders received average yields of 2.08%. Apple's P/E starting expanding in 2017. By Dec. 10, 2021 APPL's P/E was 32-times, more than double its 2011 to 2022 average level of 14.6-times. The stock yielded just 0.49% at that moment vs. a more typical 1.79%. AAPL's price to Book Value and Price to Cash Flow ratios were equally out of bounds with the firm's normalized levels. Apple carved out a new all-time peak of $182.94 on Jan. 4, 2022, getting even pricier. If you didn't sell, or worse, bought on momentum you aren't happy about it. The shares changed hands as low as $138.80 intraday on May 12, 2022. As of May 15, 2022 AAPL was $147.28 and yielding only 0.62%. That left it still pricey, by historical normals, at about 23.9-times its fiscal 2022 estimate. Assume a more typical, but still higher than average, valuation of 20-tiimes and there's still just support for about $123 by the end of fiscal 2022 by October. Surprisingly, Berkshire Hathaway , still added to AAPL, its largest single holding, in the first quarter of this year. It could have added much, much cheaper following the March of 2020 Covid-crisis and for many months after. Now let's analyze Microsoft on the same criteria. From 2011 through 2016 the stock's average P/E was 13.4-times, accompanied by about 2.3% in current yield. Early in that period value investors could own MSFT as low as 8.8-times forward EPS while collecting over 3% in yield at the start of 2012. Microsoft started seeing significant P/E expansion in 2015 and beyond. At last November's peak price of $349.67 traders were ponying up 43.4-times trailing earnings while accepting just 0.64% yields. Paying more than everybody else for the exact same shares is never a good strategy. Since then MSFT had declined by greater than 25.3% based on its May 15 quote. Did that make it a good value? Nope. It was still fetching 27.9-times its 2022 estimate while its yield had only crept up to 0.95%, less than half its historically normal level. Where does that leave us today in deciding how to position ourselves? Many big-cap stocks look exactly like AAPL and MSFT. They are less expensive that six months earlier but still overpriced. From 1999 through 2006 stocks like that are likely to remain poor performers as they continue to work off their valuation excesses via P/E compression. That doesn't mean there's no money to be made, though. Many excellent smaller-cap companies are now offered at ridiculously cheap valuations. Quite a few have juicy yields as well. Here is a reprint of some of my top picks as of May 11, 2022. Each of them still look great. All had been ravaged by the bear market even though they are all profitable. Every one of them has upside potential which could be life-changing for those betting big. It would not surprise me if the final bottom for the broader market was set last Thursday morning before a late day rally kicked in and extended through Friday. Returns for still-pricey shares, though, are unlikely to be stellar. Stick with stocks which are priced at fractions of their historically normalized P/Es like the ones listed above. I also like, and added, to real estate investment trusts last week. My new buys in that area were in Simon Property Group and Macerich . Both posted better than expected funds from operations (FFO) last week. Each pays a nice current yield. SPG raised both its quarterly dividend and forward guidance for 2022. History says value stocks will be the place to be over the next few years.

Think Big, but Go With Small Caps

Contrary to popular opinion, since December 1999, shares of small-cap and mid-cap companies posted far superior total returns than mega-cap stocks. Here's what that means for how to invest now.

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