The Value Premium for Small-Capitalization Stocks

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.