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Big Stocks vs. Small Stocks - 10627 views
MINNEAPOLIS (Stockpickr) -- The January effect is over. The supposed period when smaller-cap stocks outperform larger-cap stocks did not really materialize this year. In fact, small-cap stocks lost value in the month, while large-cap stocks gained more than 2%.
For the month, the S&P 500 moved higher by 2.3%. The Russell 2,000 was down fractionally. The dichotomy was a bit of a surprise and may signal a shift in where gains are to be had going forward.
Everything in the market tends to revert to the mean. At the start of a new economic cycle, it is said that small-cap stocks gain the most since such companies are more nimble and have the ability to grow earnings quickly.
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As the economic cycle matures, it is the big stocks that take over. The underperformance is replaced by outperformance fueled by profit growth during stable economic expansion.
Some suggest that we are now entering a more mature phase of the recovery and that large cap-stocks are the place to be. Others still think small-cap stocks will do best as earnings growth is still strong.
The debate is an interesting one. In order to further explore the question of big vs. small, I wanted to take a look at specific industries to ascertain what size companies are likely to do best. Where is the best value for an investor looking to maximize returns in the future?
Here is a look at three sector, and a large and small stock in each.
Beverages: Coke vs. Cott
It is hard to believe a simple little formula developed by a pharmacist in Atlanta could become one of the world’s biggest companies and best-known brands, but that is exactly what Coca-Cola (KO) has become. With a market cap of almost $150 billion, Coke is also a very big stock.
On the flip side is tiny-by-comparison Cott (COT). With its Cott Cola and RC brands, this little beverage company has managed to survive in a world dominated by Coke and Pepsi. With a market cap of under $1 billion, the odds would seem to be against tiny Cott.
What stock offers better value?
With Coke, investors are getting modest growth and a big fat dividend check. Shares trade for a premium 16 times 2011 estimated earnings with a company expected to grow profits by 10%. In addition, investors receive a dividend of 2.8%.
With Cott, investors are getting growth at a reasonable price. Analysts expect the company to post a profit of 75 cents a share in the year ended Dec. 31, 2010, with that number jumping 18% to 89 cents a share in 2011. At current prices, investors are buying that expected growth for just 9 times 2011 estimated earnings.
From a pure stock performance standpoint, one would expect Cott to do better than Coke over the remainder of the year. To the extent that Cott delivers on expectations, share prices should gravitate significantly higher compared with Coke.
Beer: Anheuser-Busch vs. Craft Brewers Alliance
This battle seems unfair. Anheuser-Busch InBev (BUD) and its Budweiser Clydesdales would seem to be able to crush a tiny upstart like Craft Brewers Alliance (HOOK), just as it did every other small local brewer over the last 100 years.
Ah, but today is not yesterday, and craft brewing is on the upswing. Some consumers have gravitated to unique brews instead of watered-down, mass-produced big-name beers. The leader in the specialty label beer is Boston Beer (SAM) and its Samuel Adams brand, but there are a number of other smaller beer makers trying to carve out a niche.
One of those names is Craft Brewers Alliance and its Redhook and Widmer Brothers brands of beers. This crafty little upstart has been around for a while and has seen good times and bad. Since bottoming in 2009 below $1 per share, the company has rebounded to a current price of $7.50.
It's not a bad run, and it shows just how resilient the company can be. That said, shares trade for nearly 50 times trailing earnings but only 1 times sales and 1.5 times book value. The company will have to grow earnings quickly to justify such a valuation.
The bet for investors is whether the company can go from 13 cents per share of earnings in the last fiscal year to, say, a buck a share. In that case, this stock is cheap. Even if the company grows to 50 cents a share, the stock would trade for 14 times earnings.
As for Anheuser-Busch, investors are paying a premium for owning such a stalwart and large name. Analysts expect the King of Beer to make $3.15 a year in the year ended Dec. 31, 2010, with that number jumping 20% to $3.77 a share in 2011. Investors can buy that growth for just 14 times earnings.
That is cheap, and considering the strength of the consumer, the company is likely to exceed expectations. The prospects for growth at Craft Brewers may be attractive, but the risk is high.
Based on valuation and risk, the play here is to go big. Anheuser-Busch wins the battle hands down.
Steel: U.S Steel vs. Schnitzer Steel
The steel industry plays such an important role in the economy. Manufacturing relies on a steady flow of steel, and m uch can be interpreted about the health of business activity based on the profitability of the steel companies.
From a large and small company standpoint, it is interesting to note the surprising strong development and growth of the mini-mill steel company. Using scrap metal that is melted down to produce new product, these mini-mills have carved out a very profitable niche.
For example, Schnitzer Steel's (SCHN) market cap of well over than $1 billion is still just a fraction of the market cap of U.S. Steel's (X) and its $9 billion market cap, but Schnitzer is gaining ground.
Analysts expect Schnitzer to make $4.07 a share in the year ending Aug. 30, 2011, and $5.27 a share in 2012. That gives the company a valuation of 15 times 2011 earnings and 11 times 2012 earnings. Given that the estimated earnings growth rate between 2011 and 2012 is 29%, Schnitzer’s market cap is likely to increase.
U.S. Steel posted a loss in 2010. Wall Street expects that loss to become a profit of $3.54 a share in 2011 and $5.72 a share in 2012. That is impressive growth for such a large company. At current prices, U.S. Steel trades for 16 times 2011 estimated earnings and 10 times 2012 estimated earnings.
With earnings swinging from a loss to a profit in 2011 and then jumping 62% in the following year, investors in U.S. Steel are getting a steal (pun intended). With such a growth/valuation scenario, I would select U.S. Steel as the stock to buy.
Schnitzer is a buy as well, but if I had to choose one, I would go big.
To see these stocks in action, visit the Big Stocks vs. Little Stocks portfolio.
At the time of publication, author had no positions in stocks mentioned.
Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.