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The Case Against Small Caps

FYI: In the David vs. Goliath scenario, a smaller, weaker character faces down and defeats a larger and stronger opponent. Such triumphant underdog storylines abound in the realm of business: Think Netflix vs. Blockbuster, Alibaba vs. eBay in China, or Amazon vs. Barnes & Noble.

For small companies, survival is much more of a struggle than for their larger, more established counterparts. Their greater challenge is reflected in higher business risk. In the US stock market, the smallest 10% of companies by market capitalization exhibited annualized volatility of 15.3%, compared to 14.1% for the largest 10%, according to data going back to 1926 from the Kenneth R. French Data Library.

Investors naturally expect to be compensated for holding riskier stocks. But the Size factor, which represents a strategy of buying small-cap stocks and shorting large caps, has not generated attractive returns over the last 90-plus years. But maybe market capitalization is the wrong metric. Could different measurements of size have generated better performance?
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