The Death of MicroCaps?

The first headline on Yahoo Finance yesterday morning was calling for the forever outperformance of large-cap US growth stocks.

Link: The New Normal of Growth Stock Dominance

This feels very toppy, doesn't it?

A few quotes from the article (emphasis mine) 👇

''In fact, the performance gap between US large and small caps has widened considerably over the last two-and-a-half years, according to a new analysis by DataTrek co-founder Nicholas Colas, who wrote in a recent note to clients that the duration of the relative outperformance suggests it's structural rather than cyclical.''

"Relative return data suggests that there is a 'new normal' at play in US stock markets, one where large caps and Growth have the upper hand versus small caps and Value," he wrote. "Moreover, enough time has passed that these differences look durable rather than being temporary anomalies."

''That's probably cold comfort for close watchers of the Russell 2000, which has underperformed the broader market this year, posting a loss of about 1% compared to the S&P's 6% gain. It's difficult to imagine market sentiment shifting away from Big Tech, especially amid the fresh trade uncertainty unleashed on Monday.''

''Rejuvenated bulls see even greater gains ahead, motivated in part by the seeming invincibility of the tech trade, itself a kind of defensive play to weather realigned global trade.''

⚠️ Remember the most dangerous words in investing: THIS TIME IS DIFFERENT.

When people forget that markets are cyclical and write articles like this, history has proven them wrong time and time again. There's no such thing as invincible companies that should be bought at any price.

The price you pay matters in the long run.

The S&P 500 is trading at a trailing P/E ratio of 28x, compared to 17x for the Russell 2000. And I would argue many Canadian small caps are even much cheaper today.

For example, in the Rivemont MicroCap Fund I manage, we own:

• A cannabis licensed producer growing revenues 30%+ this year, trading at an 11x trailing P/E ratio (and even cheaper on a forward P/E).

• A water treatment services firm with a 3-year revenue CAGR of 32% trading at a 10x trailing P/E.

• An entertainment technology stock that is up almost 300% in the last year and is still trading at only 13x trailing EV/FCF.

Based on forward multiples, I believe several of the fund’s holdings trade at less than 10 times earnings or free cash flows. The valuation disconnect between microcaps and large caps blows my mind.

If the trend holds for the remainder of the year, US large caps are expected to have outperformed small caps (Russell 1000 vs. 2000) during 11 of the last 12 years, including the previous 9 years in a row.

Unless you believe this time is different (you probably shouldn't), it's pretty clear where the best returns are likely to be over the next decade.

As you would expect, I’ve placed my chips in microcaps, and I’m patiently waiting for this mega-trend to reverse.

Are microcaps structurally dead? We shall see, but I don’t think so!

---

Disclaimer

This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont. Rivemont may own positions and transact on any securities mentioned in this publication at any time without prior notice. Always do your own research and consult a professional before making investment decisions.

If you’d like to invest in small public companies, check out this post.