Draft Picks and Value Stocks
In the wake of the recent NFL draft, Senior Investment Director Wes Crill discusses the long-term risks of overemphasizing a prospect’s weaknesses.
During the National Football League’s recent draft, teams selected from hundreds of prospects to build rosters for the future. It’s my favorite sporting event of the year, mainly because it provides an opportunity to see professional evaluators miss wildly with their projections.1 And while many sources of uncertainty contribute to these misses, NFL teams are often derailed by a self-inflicted error: focusing too much on a prospect’s weaknesses at the expense of all their strengths.
I was thinking about this lesson in the context of small cap value performance. Many investors have expressed concern over small cap value stocks underperforming large caps in the US over the 20 years ending in January. But this was largely an outlier from a global perspective. In major non-US markets, small cap value stocks handily outperformed their large cap counterparts over this period. While a two-decade stretch of underperformance is not what investors hope to see from US small value, it’s important to take notice of what went right for small value over this period.
EXHIBIT
120-year annualized return differences between small cap value stocks and large cap stocks
As of January 31, 2024
Thinking globally also reinforces the importance of diversification when emphasizing small cap value stocks. The returns for these stocks may not move in lockstep across regions, and outperformance for non-US stocks can mitigate the impact of disappointing relative returns in the US.
FOOTNOTES
1. This is probably why I enjoy working in finance as well.
APPENDIX
INDEX DEFINITIONS
The Dimensional indices have been retrospectively calculated by Dimensional Fund Advisors LP and did not exist prior to their index inception dates. Accordingly, results shown during the periods prior to each index’s index inception date do not represent actual returns of the index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.
The Dimensional Indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment.
Dimensional US Small Cap Value Index was created by Dimensional in March 2007 and is compiled by Dimensional. It represents a market-capitalization-weighted index of securities of the smallest US companies whose market capitalization falls in the lowest 8% of the total market capitalization and whose relative price is in the bottom 35% of the eligible market, or 25% prior to January 1975, after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The eligible market is composed of securities of US companies traded on the NYSE, NYSE American, and Nasdaq Global Market. Exclusions: non-US companies, REITs, UITs, and investment companies. From January 1975, the index excludes companies with the lowest profitability and highest relative price within the small cap universe. The index also excludes those companies with the highest asset growth within the small cap universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Source: CRSP and Compustat. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in December 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional International Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Exclusions: REITs and Investment Companies. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalization conditional on the securities being in the bottom 10% of market capitalization, excluding the bottom 1%. All securities are market capitalization weighted. Each country is capped at 50%. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Emerging Markets Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to the current fiscal year. Maximum index weight of any one company is capped at 5%. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Europe Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Dimensional UK Small Value Index and Dimensional Europe ex UK Small Value Index combined using small value country weights. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Asia Pacific Small Cap Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies in eligible markets whose relative price is in the bottom 35% of their country’s respective constituents, after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. Prior to January 1990: Includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalization conditional on the securities being in the bottom 10% of market capitalization, excluding the bottom 1%. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
Dimensional Canada Small Value Index was created by Dimensional in April 2008 and is compiled by Dimensional. Consists of small cap companies whose relative price is in the bottom 35% of constituents after the exclusion of utilities and companies with either negative or missing relative price data. The index excludes securities with the lowest profitability within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. Exclusions: REITs and investment companies. Source: Bloomberg. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index and in November 2019 to include asset growth as a factor in selecting securities for inclusion.
DISCLOSURES
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
CANADA
These materials have been prepared by Dimensional Fund Advisors Canada ULC. The other Dimensional entities referenced herein are not registered resident investment fund managers or portfolio managers in Canada.
This material is not intended for Quebec residents.
Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
Resources
