Is the Biggest Lie in Finance Costing You $900,000?

Few Ph.D papers have been more influential than economist Eugene Fama’s 1965 thesis.

Fama’s hypothesis helped spark a school of thought in finance that held that all efforts to beat the stock market over the long term were futile.

Called the efficient market hypothesis, it maintains that all of the relevant information concerning a company’s prospects would already be known and “priced into” the stock.

Individual investors might pick a stock they felt could yield outsized returns, and a few might get lucky and beat the markets for a short while.

But the efficient market hypothesis held that eventually, investors’ performances would fall in line with the stock market’s overall performance.

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The theory is comforting to many. It would mean there’s no need — or point — to analyze an individual stock’s fundamentals and earnings and no need to pore over balance sheets or follow earnings reports.

Just buy shares of an index fund, and sit back for years or decades knowing you’ve done all the due diligence you possibly could.

But as comforting as the theory might be, it’s completely wrong.

Why Alpha Exists – and How to Find It

Amid all the theorizing, one thing that’s undeniable is the ability some stocks have shown to thrash the overall stock market’s performance over time.

Not just a few years here and there. Decade after decade.

According to data from Portfolio Visualizer, small-cap stocks — companies with valuations under $2 billion — have outperformed larger companies’ returns by an average 0.9% annually since 1972.

If an extra 0.9% each year sounds trivial, consider the 50-year return of $10,000 invested in small-cap companies over this period.

The small-caps’ average annual return would have turned $10,000 into $2.86 million. But the same $10,000 invested in large caps would have amounted to just $1.93 million.

Investors settling for investing in household names like The Coca-Cola Co. and IBM that make up the S&P 500 might be leaving as much as $900,000 on the table by shunning small-cap investing.

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It’s just one study, and many investors do well by backing larger-cap companies for decades. But investors who truly embrace small caps — backing both winners and losers in the sector — have dramatically outperformed large-cap investors over the last 50 years.

The numbers do the talking. It’s hard to think of a more wrong — and costly — myth in finance than the efficient market hypothesis.

At the same time, these small-cap stocks — many with unproven products and only theoretical appeal — are risky. For each story, like Amazon.com Inc.’s rise from a penny stock in the late 1990s or Apple Inc.’s successful turnaround from near bankruptcy, there are hundreds of companies that didn’t make it.

Benzinga is tracking a handful of opportunities in the small-cap space — firms that are risky but may also present investors with a chance to multiply their initial investment.

For investors wishing to play the rise in startups without backing any single new company, one option is StartEngine, a leading equity crowdfunding company that counts Kevin O’Leary of “Shark Tank” fame among its venture capitalist backers.

StartEngine already has 1.7 million users and has raised over $1.1 billion in its mission to tear down traditional barriers to entry for startup investing and become an equity crowdfunding juggernaut.

For a limited time, investors can claim a stake in StartEngine.

See more on startup investing from Benzinga.

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