Some Canadian gardeners are starting to pick perfectly sized zucchini. Those of us who are less attentive will tarry and discover obese specimens when they next visit the vegetable patch.
Size also matters for investors and small value stocks can be quite rewarding. The Screaming Value portfolio is a case in point because it tends to buy smaller stocks. I’m going to check in on it today and divide it up by size.
The original Screaming Value portfolio outperformed this century with average annual returns of 14.2 per cent over the 25 years to the end of July, 2024. It beat the S&P/TSX Composite Index, which gained an average of 7.6 per cent annually over the same period. (The returns herein are based on monthly data from Bloomberg and include dividend reinvestment but not fund fees, commissions, inflation or other trading costs.)
The Screaming Value portfolio starts its search for bargains with the largest 300 stocks on the Toronto Stock Exchange by market capitalization (share price times shares outstanding). It then picks the 10 with the lowest EV/EBIT ratios and puts an equal amount of money in each one. (In simple terms, enterprise value, or EV, is the market value of a company’s equity plus its net debt, while EBIT is an abbreviation for earnings before interest and taxes.) The portfolio is refreshed or rebalanced monthly.
The original method is modified to form a large portfolio and a small portfolio. The large portfolio starts with the largest 100 stocks on the TSX and then picks the 10 with the lowest EV/EBIT ratios. On the other hand, the small portfolio starts with the 200 smallest stocks from the 300 largest stocks on the TSX and then picks the 10 with the lowest EV/EBIT ratios.
As a result, the large portfolio currently picks from stocks with market capitalizations between $211-billion and $5.8-billion. The small-stock portfolio picks from stocks with market capitalizations between $5.8-billion and $580-million.
You can examine the return history of the three value portfolios, and the market index, in the accompanying graph.
The small portfolio was the top performer of the bunch with an average annual return of 16.1 per cent over the 25 years to the end of July, 2024. On the other hand, the large portfolio failed to keep up with the market index with an average annual return of just 6.8 per cent over the same period.
(Last November, I discussed the Screaming Value portfolio’s propensity to suffer from shockingly big downturns and both the large and small versions of it also performed poorly on the downside.)
The large and small portfolios aren’t only separated by size. They also happen, at the moment, to be separated by EV/EBIT. The large portfolio currently contains companies with EV/EBITs ranging from 5.8 to 10.6. On the other hand, the small portfolio has stocks with ratios ranging from 1.1 to 5.4.
The small stocks are better bargains than the large stocks based on their EV/EBIT ratios, which may help to explain the return difference between the large and small portfolios. Of course, there are more small stocks to choose from than large ones, which improves the odds of finding bargains among the small fry.
I hasten to add that the Screaming Value portfolio currently holds the same stocks as the small portfolio thanks to the 10 lowest EV/EBIT stocks making their home in the small portfolio.
It’ll be interesting to see how the portfolios perform and grow over time, but I tend to favour the smaller low-ratio stocks. Just be warned, the portfolios are far from risk-free and will likely provide a very bumpy ride that may bruise some zucchinis along the way.
You can find the stocks in the Screaming Value portfolio via this link, which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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