Academics and practitioners in finance have long accepted the notion that small market capitalization stocks earn higher returns, after adjusting for risk, than large market capitalization stocks. They have often followed through by either investing in small cap stocks, hoping to earn these higher returns, or by augmenting the required returns (discount rates) for smaller companies with a “small cap premium” when valuing these companies. In this article I argue that these practices are misguided because the small cap premium is no longer supported by the historical data, does not seem to be priced in by investors in markets today, and is based on faulty intuition.
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