S&P 600

4.5% on a price basis.

Now that's exclusive of dividends, which the S&P 500 would be paying more of, but regardless on a total return basis, the S&P 600 would still be ahead.

And as for why we see this, there are two sort of theoretical explanations.

The first being that smaller cap companies tend to have an easier time growing their operations than a large company that's already well-established and more mature.

Now, perhaps you're someone who wants to take advantage of index investing, but doesn't necessarily like the idea of making those active calls and just wants more broad market exposure.

There are a lot of options, even within just the US market for different sorts of allocations.

The S&P Super Comp, for example, includes the S&P 500, the S&P 600, as well as the S&P 400, which is a mid cap index.

to capture more of the stock market.

Yeah, I mean, quality small caps have been a really strong trade this year.

I think if you look at broad diversified indices, the S&P 600, for example, is up around 22%, 23%, which is well ahead of the Dow, the Nasdaq, and the S&P 500.

And this is in spite of you know, a higher rate environment.

If we go back just a couple of years, this level of the 10 year would absolutely destroy small caps.

There are companies like Morningstar that give them grades, which are good, but you really need to dive in and understand what those ETFs are investing in.

So if I'm looking for a small cap, US small cap fund, The S&P 600, which calls itself a small cap index, has a lot of mid cap exposure.

So if I purely want small cap exposure, that's not where I should go.

Your question should be, how good of a job does this specific ETF do at attacking the asset class or theme or whatever thing I'm trying to invest in? That's number one.

There are lots of opportunities to differentiate between stocks for skilled active management.

And the valuation, well, if you look at the S&P 600, which has the companies that are generating positive earnings, that index relative to large cap in terms of its price earnings ratio is still in the bottom 30% of its long run historical range.

So you have a valuation advantage.

And while small and mid-caps are participating increasingly in the AI trade, this golden component for example, it is clear that when markets sell off on AI news, counterintuitively, 'cause you think of small and mid-caps as more cyclical, they're a- they actually do better.

When we talk about we're a value manager that happens to buy dividend paying stocks, especially in the small mid cap area, they're like, why? And when you walk through the positive attributes as to why.

The first one is they actually yield more than large caps, right? The S&P 600 yields more than the mid cap, the S&P 400 and the S&P 500.

Now, that tends not to happen throughout time, but we're in an environment where that is the case.

The opportunity set is also much larger as you go up cap rates.

Um, uh, so it l- it turns out that if there are two small cap indices that have, are prominent, um, there's the Russell 2, um, which is almost perfectly balanced across, um, uh, the junk and the profitable firms.

Uh, and then there's the S&P 600, um, which has a profitability filter, uh, and so eliminates a lot of the unprofitable ones.

Um, so I think as a buy and hold investor, I love that S&P 600 small cap index.

I think it's a much better index for long-term buy and hold.

Um, but if you look over the last year when, you know, unprofitable, you know, junks, junky stocks have rallied, uh, the Russell 2 has outperformed.

[laughs] You would have missed it

...

S&P 600, yeah.

think that you're capturing a broad part of the market, right? So you're like, well, you know, different indices probably do it differently.

But how, you know, how different could they really be? Small caps are small caps, aren't they? And actually, when you look at just three indexes alone, which is the S&P 600, the Crisp US Small and the Russell 2000, which are all very, very well known and highly used US small cap indices.

On average, over the last 20 years, the difference between the top performing and bottom performing US small cap index of those three has been like 5% a year, roughly.

which is enormous.

That is a huge difference between what you thought was basically a non-decision, right? It doesn't matter if you're in the S&P 600 versus Russell 2000, right? You maybe pick one because you like the name or the fees or whatever it is.

But that's just that return dispersion is enormous.

And you can imagine that if you were in one of these funds, And you underperformed another index fund by 12% in a year, which, as you can see on the slide, does happen.

Right.

The research comparing the Russell 2000 to the S&P 600.

I found this staggering.

It perfectly highlights the danger of passive small cap investing.

Right.

It includes zombie companies that are bleeding cash, completely buried in debt, and practically on the verge of bankruptcy.

Whereas if you look at the S&P 600, it requires a company to actually prove its viability before it even gets included.

Like an entry fee.

The Russell 2000 is heavily diluted by these cash-burning biotechs waiting for miracle FDA approvals and, you know, dying mall retailers.

Contrast that with the S&P 600 small cap index.

The S&P 600 employs a profitability screen.

It acts as a strict bouncer at the club door.

I like that.

The Cabot data highlights this beautifully.

Look at the 2024 earnings per share, or EPS projections.

The ETF tracking the S&P 600, the ticker is IJR, has a projected EPS of $6.78.

And when you look at markets that are really poised to that, I think looking at areas that have you know, high-quality overall earnings, but lower starting margins are a great place for that.

I think one of the areas, broad index-wise, that you can look at this year that might surprise a lot of investors is the S&P 600, right? So this is a little bit more higher earnings quality than the broader Russell 2000 in the small-cap space.

That's one of the absolute top performers on the year, up about 25% ahead of the NASDAQ and S&P.

That is an area where, because of the lower starting margins, and as you have this AI kind of seep through the broader economy, those increasing margins are going to have a lot more bang for their buck on increasing earnings for those areas of the market.