In the early stages of an economic recovery, the stocks of small companies outperform the shares of the big guys. Take a look at the 3,000 U.S. stocks tracked by the Frank Russell Co. for its indices.
So far in 2003, the Russell 1000 stock index, which tracks the performance of the stocks of the largest 1,000 companies, is up 17%.
The Russell 2000, which tracks the performance of the smallest 2,000 stocks, is up 32% for the year to date. (The stocks in the Russell 2000 account for about 8% of total market capitalization of the Russell 3000.)
Often, as an economic recovery advances, big-company stocks begin making up the difference. That's because these companies can use their massive advantages of scale to reap more than their share of the economic pie.
Small Victories, Big Gains
But in this economy, small-company stocks should keep leading the way. That's because the economy is rebounding in this recovery at a slower pace than usual, and it looks like growth will remain relatively modest even as the recovery continues. That will play to the leverage that's built into small-company stocks, which are far more likely to react to even modest increases in sales and earnings than big companies. The latter have to show massive increases in sales volume to produce a measurable change in their bottom lines. Think of it this way. General Electric ( GE) added $668 million in sales in the third quarter of 2003 from the same quarter of 2002. But that was a paltry 2% of the company's $33.4 billion in third-quarter revenue. On the other hand, a company like Calavo Growers ( CVGW), one of the stocks on my list of micro-cap winners, increased sales of its avocados and papayas by a comparatively tiny $4.9 million in the third quarter of its fiscal 2003 from the same period in 2002. But that amounted to a 6.5% increase from the $76 million in sales recorded in the fiscal third quarter of 2002. Guess which stock is up more in the last three months? Calavo Growers, which began life as an avocado cooperative in California and bills itself "the first name in avocados," gained 16% in the period. GE is down 1%.