have persisted over time and are difficult to explain in an efficient mar-
ket model.
Trends in Small-Cap Stock Returns
Although the historical return on small stocks has outpaced large stocks
since 1926, the magnitude of the small-cap stock outperformance has
waxed and waned unpredictably over the past 80 years. A comparison
of the cumulative returns on small stocks with those of the S&P 500
Index is shown in Figure 9-1.^9
Small stocks recovered smartly from their beating during the Great
Depression, but they still underperformed large stocks from the end of
World War II until almost 1960. In fact, the cumulative total return on
small stocks (measured by the bottom quintile of market capitalization)
did not overtake large stocks even once between 1926 and 1959. Even by
the end of 1974, the average annual compound return on small stocks ex-
ceeded large stocks by only about 0.5 percent per year, not nearly enough
to compensate most investors for their extra risk and trading costs.
But between 1975 and the end of 1983, small stocks exploded. Dur-
ing these years, small stocks averaged a 35.3 percent compound annual
return, more than double the 15.7 percent return on large stocks. Cumu-
lative returns in small stocks during these nine years exceeded 1,400 per-
cent. Figure 9-1 shows that if the nine-year period from 1975 through
142 PART 2 Valuation, Style Investing, and Global Markets
TABLE 9–1
Returns on 10 Groups of 4,252 Stocks Sorted by Market Capitalization, 1926 through December 2006(^9) The small-cap stock index is the bottom quintile (20 percent) size of the NYSE stocks until 1981,
then it is the performance of Dimensional Fund Advisors (DFA) Small Company fund from 1982
through 2000, and then it is the Russell 2000 Index from 2001 onward.