The Value Premium for Small-Capitalization Stocks

Abstract

We investigated whether an exploitable value premium existed for stocks in the Russell 2000 Index, the commonly used U.S. small-cap benchmark, in the 1979–97 period. For portfolios formed on the basis of price-to-earnings, price-to-sales, and market-to-book ratios, value stocks in the study outperformed growth stocks by 5.28–8.40 percentage points a year and had lower standard deviations and lower coefficients of variation than growth stocks did. Combining the valuation measures to identify value boosted returns and improved the risk–return characteristics of value portfolios. Most of the value premium for small-cap stocks occurred outside the month of January and was available for reasonably liquid stocks. These findings suggest that small-cap stocks offer a substantial value premium that is of practical significance to investors.