Does Size Matter?

8/31/2015


While Dow Theory Forecasts features mostly large-cap stocks, don't assume that means our analysts only like big companies.

At the moment, 10 of the 28 stocks on our buy lists have market capitalizations between $3 billion and $10 billion, and 50% of our Focus List is comprised of such midcaps. In addition, our editors also select stocks for sister newsletter Upside, which focuses on small stocks. You might say we love large, medium-sized, small, and tiny stocks, so long as they score well in our Quadrix stock-rating system and fit our growth-at-a-good-price philosophy.

This week we decided to see how much size matters, so we sliced the market into

four groups by stock-market value:

• Large-cap, above $10 billion.
• Midcap, $3 billion to $10 billion.
• Small-cap, $1 billion to $3 billion.
• Microcap, up to $1 billion.

Not surprisingly, most U.S.-traded stocks fall into the microcap category, giving Upside a lot of potential targets. But with more than 1,200 qualifying as large-caps or midcaps, the Forecasts also has plenty of opportunities.

CAPITALIZATION COMPARISON
All of the numbers below are averages for large-cap, midcap, small-cap, and microcap stocks except the number of stocks and the percentage of stocks paying dividends and reduring share counts.
Large-Caps
(Above
$10 Bil.)
Midcaps
($3 Bil. To
$10 Bil.)
Small-Caps
($1 Bil. To
$3 Bil.)
Microcaps
($1 Bil. Or
Smaller)
Number of stocks in group
569
687
907
2,802
Dividend yield (%)
2.4
2.0
2.0
1.3
Yield of dividend-payers (%)
3.0
3.1
3.6
4.0
% of stocks paying dividends
82
65
56
34
3-yr. annualized change
in share count (%)
0.6
2.2
3.7
5.9
% reducing share count
55
41
28
19
Total return
3 months (%)
(11)
(11)
(12)
(15)
6 months (%)
(10)
(10)
(10)
(15)
12 months (%)
(2)
(3)
(4)
(17)
Valuation
Trailing price/earnings ratio
20
21
21
18
Premium to 5-year average (%)
(2)
(7)
(8)
(8)
Trailing price/sales ratio
2.6
2.6
2.4
1.9
Premium to 5-year avg. (%)
9
4
(1)
(14)
Growth, last 12 months
Sales (%)
2
7
10
7
Per-share earnings (%)
3
5
5
0
Cash from operations (%)
2
4
8
-4
Growth, last 5 years annualized
Sales (%)
6
9
8
5
Per-share earnings (%)
9
10
7
3
Cash from operations (%)
7
9
8
3
Estimated EPS growth
Current year (%)
6
4
5
2
Next year (%)
13
13
16
21
Quadrix scores
Momentum
47
52
54
49
Value
53
51
51
49
Quality
64
63
57
42
Financial Strength
61
57
53
45
Earnings Estimates
53
51
50
49
Performance
57
56
54
46
Overall
57
57
55
46
Notes: Averages exclude some outliers. Quadrix scores are percentile ranks, with 100 the best.

We looked at the four market-cap groupings from five angles. Here's what we found:

Dividends and buybacks

Large-cap stocks average dividend yields of 2.4%, versus 2.0% for midcaps and small caps, and 1.3% for microcaps. However, the average misses part of the story. More than four of every five large-caps pays a dividend, while just one-third of microcaps do. Average the yields of just the stocks that pay dividends, and small-caps and microcaps have richer payouts. Financials account for more than 50% of all microcap dividend-payers and average yields of 4.0%. However, microcap dividend-payers also deliver higher average yields than larger stocks in most other sectors.

In general, dividends become scarcer and yields higher as stocks get smaller. Given those trends, no group has a big edge. We lean toward larger dividend stocks, which tend to offer greater variety, making it easier to build a diversified income portfolio. In addition, large-caps are far more likely to repurchase enough shares to shrink their stock counts.

Winner: Large-caps
Losers: Small-caps, midcaps

Returns

The big boys hold an advantage here. All types of stocks are down over the last three, six, and 12 months, but large-caps and midcaps posted smaller declines. Over the last 12 months, large-caps averaged negative total returns of 2% and midcaps negative 3%. In contrast, microcaps were the weakest in average three-, six-, and 12-month returns.

Winners: Large-caps, midcaps
Loser: Microcaps

Valuations

While the largest stocks may not have the highest valuations, they are the most expensive relative to historical norms. Stocks with market capitalizations above $10 billion average trailing price/earnings ratios of 20, lower than the average for midcaps and small-caps, but trade at an average of just 2% below their five-year average P/Es. Large-caps average a 9% premium using price/sales ratios.

In contrast, the smallest stocks are notably cheaper than the rest and tend to trade at discounts to their five-year averages for P/E and P/S ratios. But we'll tap the brakes a bit on the idea of microcaps as deep values. Those stocks average Quadrix Value scores of 49. None of the other groups average more than 53, so the spread between top and bottom is narrow. Still, microcaps' lower Value scores are worth mentioning.

Winner: Microcaps
Losers: Large-caps, midcaps

Growth

When it comes to sales, profit, and operating-cash-flow growth over the last 12 months, midcaps and small-caps tend to look better than the biggest or smallest stocks. Same with five-year growth, although large-caps aren't far behind. In five of the six historical-growth metrics we considered, microcaps came in dead last. However, the picture changes when we look ahead.

Stocks in the three largest groups are all expected to average at least 4% profit growth this year, higher than the average of 2% for microcaps. Analysts expect smaller stocks to separate from the pack next year, with microcaps averaging 21% growth.

Of course, while growth targets for the next fiscal year look attractive, the further out we look, the blurrier the picture. The high-risk, high-reward nature of microcaps suggests that even if they do average 21% profit growth next year, an awful lot of them will deliver far less.

Winners: Midcaps, small-caps
Loser: Microcaps

Quadrix

Microcaps earn substantially lower Overall scores than their larger brethren, while the other three groups (large-cap, midcap, and small-cap) all earn fairly similar Overall scores. Other trends differentiate between the groups, such as higher Momentum scores for midcaps and small-caps to reflect their superior growth and higher Financial Strength scores for large-caps to reflect their superior balance sheets. However, the tight spread in Overall scores captures the essence of the issue.

Winners: Large-caps, midcaps, small-caps
Loser: Microcaps

What it means

Based on our analysis, midcap and small-cap stocks have the fewest obvious weaknesses but achieve little separation from large-caps. In our view, the large-cap and midcap pools where the Forecasts dips its hook should yield an appealing catch, particularly if we limit ourselves to the choicest spots, such as where the top Quadrix Overall scorers hang out.

The smallest stocks seem riskier than the rest, but that's nothing new. Upside has done pretty well with microcaps in recent years using a short-leash strategy, and Quadrix can also help in this area.

The table below presents five of our favorite picks from each capitalization group, most either Forecasts Focus List Buys or Upside Best Buys.

TOP PICKS OF ALL SIZES
Below we present five excellent options for each of four groups of stocks. All 20 are recommended for purchase by either the Forecasts or its sister publication , which focuses on smaller stocks. Upside picks are in green.
Stock-
Market
Value
($Mil.)
-- Total Return --
-- Price/Earnings --
-- Growth, Last 12 Months --
Est. EPS Growth
Company (Price; Ticker)
Div.
Yield
(%)
3
Months
(%)
12
Months
(%)
Trailing
Premium
To 5-Yr.
Average
Sales
(%)
Per-
Share
Earnings
(%)
Cash From
Operations
(%)
Curr.
Year
(%)
Next
Year
(%)
Quadrix
Overall
Score
Large-caps (above $10 billion)
Alaska Air Group
($76; ALK)
10,041
1.0
23
65
14
26
6
48
25
50
6
98
Apple ($110; AAPL)
633,609
1.9
(15)
10
13
(15)
26
40
44
41
7
99
Foot Locker ($71; FL)
10,087
1.4
13
32
18
10
5
22
NA
17
11
89
Gilead Sciences
($107; GILD)
164,718
1.6
(2)
0
10
(45)
67
114
155
44
(1)
100
Google ($660; GOOGL)
490,471
0.0
21
12
25
5
14
(4)
28
13
17
82
Midcaps ($3 billion to $10 billion)
CDW ($39; CDW)
6,810
0.7
9
20
15
NA
9
23
7
22
11
93
F5 Networks
($122; FFIV)
8,812
0.0
(3)
1
19
(43)
13
29
27
21
12
96
JetBlue Airways
($22; JBLU)
7,722
0.0
14
76
17
2
8
134
41
165
12
100
Jones Lang LaSalle
($147; JLL)
6,689
0.4
(15)
11
15
(18)
15
39
10
12
6
92
Lear ($100; LEA)
7,777
1.0
(15)
2
11
4
5
59
59
23
13
99
Small-caps ($1 billion to $3 billion)
II-VI ($17; IIVI)
1,065
0.0
(8)
20
18
(8)
9
43
36
12
15
93
Innospec ($48; IOSP)
1,174
1.3
10
13
12
16
18
8
122
16
(9)
98
Korn Ferry Int'l
($33; KFY)
1,655
1.2
3
11
17
6
7
24
(17)
7
10
87
On Assignment
($35; ASGN)
1,867
0.0
(6)
18
16
(43)
11
17
17
13
27
86
Selective Insurance
($30; SIGI)
1,712
1.9
12
26
11
(46)
5
67
5
13
8
99
Microcaps ($1 billion or smaller)
Banc of California
($12; BANC)
477
3.9
(7)
5
9
NA
58
NA
NA
4
18
92
Heartland Financial
($36; HTLF)
756
1.1
8
51
13
4
17
59
NA
24
5
97
Preferred Bank
($31; PFBC)
418
1.6
11
31
16
NA
17
21
NA
18
8
95
Shoe Carnival
($26; SCVL)
508
1.0
(10)
21
19
21
8
2
62
17
14
91
Wabash National
($12; WNC)
868
0.0
(13)
(13)
12
(42)
13
40
26
45
5
100
NA Not available.

 


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