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Looking at the Evidence

In this section, you will examine the evidence that has accumulated over the last few decades on the efficacy or otherwise of investment strategies oriented around younger and smaller companies. In the first section, the returns from investing in smaller, publicly traded companies are compared to the returns of investing in larger, publicly traded firms. In the second section, the payoff to investing in stocks as they go public is examined, both around the offering date and after the offering. In the third section, you will look at whether investing in private companies (in the form of venture capital or private equity) generates high returns.

Small Companies

Thousands of publicly traded stocks are listed on the major exchanges, and they vary widely in terms of size. There are firms like GE and Microsoft whose values run into the hundreds of billions at one extreme, but there are also publicly traded firms whose values are measured in the tens of millions at the other end. In fact, there are unlisted publicly trade companies whose values can be measured in millions. Would a strategy of investing in the smallest publicly traded companies work? Studies have consistently found that smaller firms (in terms of market value of equity) earn higher returns than larger firms of equivalent risk. Figure 9.1 summarizes annual returns for stocks in ten market value classes, for the period from 1927 to 2001.[1] The portfolios were reconstructed at the end of each year, based upon the market values of stock at that point, and held for the subsequent year. The returns are computed both on value-weighted (where the amount invested in each company is proportional to its market capitalization) and equally weighted (where the same amount is invested in each company in a portfolio) portfolios.


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