Which business characteristic guarantees a premium value?

BVWire–UKIssue #19-2
October 20, 2020

valuation profession news
size premium, investment, size effect

Business valuation experts in the UK often find little benefit from the academic literature about portfolio and investment theory. The prime example of the disconnect is the ongoing debate about the size premium. Do small stocks outperform larger ones over time?

Size is not alone as a value factor, however. Any BVWire—UK reader interested in this topic will enjoy the full list of factors (Bloomberg calls many of them ‘very abstruse’) contained in Campbell Harvey and Yan Liu’s updated list of identified value factors.

Harvey and Liu had some fun with this list in their 2019 article ‘A Census of the Factor Zoo.’

The Bloomberg article last week summarised:

Academics now claim to have identified more than 400 factors (which makes it a wonder that anyone ever failed to beat the market). Meanwhile, doubts over the ‘small is beautiful’ theory have reached such a point that many question whether it exists at all.

None of the 400 have drawn as much attention as the size premium, perhaps because that factor is a standard metric in building any risk model for business valuation—or investing. This new Bloomberg article summarises what many business valuers have come to accept when it concludes that ‘the small-company effect does not, after all, exist.’ The Russell indexes show that the factor is ‘muted at best,’ and sophisticated statistical work confirms it.

It also points to several recent papers, including one by Cliff Asness (AQR), who studied for his doctorate under Eugene Fama at the University of Chicago. One finding of that paper, ‘There Is No Size Effect,’ which we covered here, is that, since the size effect was originally identified in the early 1980s, a ‘series of cumulative challenges, many of which we have summarized …, all have reduced the historic “net of market beta” return to small vs. large, ultimately leaving nothing.’ The article also points to another recent paper, ‘Settling the Size Matter,’ that ‘nearly resurrects a narrower version of the small-company effect, before finding that it is close to impossible to exploit,’ the article says.

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