How Will Covid-19 Impact Small-Cap Investing Over The Next 12 Months?
Recently, approximately 25% of the small-cap market reported negative earnings, compared to 5% reported by the large-cap market. However, as historical data shows, this is not a new development.
With recession worries increasing during the COVID-19 pandemic, many investors are wondering how small-cap stocks will perform over the next 12 months whether the pandemic is still present or not.
Do we think that small-cap companies are under more distress now than in prior turbulent economic times? And what will the lasting impact be once the dust has settled?
If we believe the economy has fallen into recession or at some point will, it does not necessarily indicate that small-cap investing performance will deteriorate
Why? Current market levels have already built-in future cash flows, including the ongoing impact of an economic recession.
Even though the small-cap companies will usually feel the brunt of an economic downturn, small-cap stocks can still produce higher than expected returns for investors as we have seen with one of our Richmond Club stock picks shown in the graph below:
TSXV:AFF
If we look at the data, the first question we want answered is if small-cap companies had been displaying any unusual or negative trends before the current crisis.
If the financial indicators for small-cap firms in recent years have been lining up with long-term averages, we can rely on the historical data to help explain the range of possible outcomes moving forward into the next 12 months.
A standard measurement used to show a company’s relative strength shown in its leverage or the value of its current debt. If a company’s financial standing has weakened during a downturn in the economy, it may see rising leverage that will be less sustainable over a long period.
If we take measurements using the total debt scaled up by the sum of assets, aggregate leverage rates for small caps have been similar to those for large caps, and have held relatively steady throughout time.
Another characteristic worth assessing if small-cap companies survive going forward after this crisis is the number of companies with negative earnings.
A business with negative earnings entering into a recession, obviously will face tougher odds of persevering through the pandemic.
Recently, approximately 25% of the small-cap market reported negative earnings, compared to 5% reported by the large-cap market. However, as historical data shows, this is not a new development.
The proportion of small caps presenting negative earnings is in line with the norm over the past few decades, in absolute terms and relative compared to large caps.
So the critical question investors ask is if this pattern will impact the future performance of small-cap stocks over the next 12 months?
We all need to remember that even if small companies are going “broke” at a higher clip than large-cap companies, it does not necessarily indicate that returns for all small-cap companies will be lower.
Rather, it makes sense to believe that expected returns for small-cap stocks as an asset class will compensate for the real possibility that a few individual companies will go out of business over the next 12 months.
Even during volatile times such as COVID 19, markets continue to function as they have over the past 100+ years, connecting buyers with sellers.
Market prices quickly absorb new information and reflect buyers and sellers going forward, including information about the financial well-being of small-cap companies and the lasting effect that the coronavirus may have on the future performance.
Investors can put themselves in a better position by gaining expert advice from financial advisors that have proven to beat the market and year over year and play the long game with investing your money.
Here at The Richmond Club, we have shown an average return of 18+% growth over the past 15 years, as indicated in the chart below:
We would encourage you to please see our Richmond Club Advisor Group that receives investment advice, stock picks, newsletter, and stock offerings throughout the year.
Please feel free to contact us at dave@richmond-dm.wp5.staging-site.io if you have any questions about the membership.
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Richmond Club Index
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S&P 500
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