Diversity Counts Among 'Styles' of Stocks
'STYLE," insists financial expert James Francis, is everything when it comes to making money from stocks.
As president and chief executive officer of Paradigm Asset Management Company, based here, Mr. Francis has around $500 million under management, mainly from institutional clients.
Paradigm is an equity "style manager." It advises clients how to structure portfolios to profit from changes in the overall economic climate. And Paradigm has made money. (Sorry, minimum investment required: $5 million.) For the three years ending Dec. 31, 1994, for example, Paradigm was ranked among the top 20 money managers in the world in several major investment categories by Nelson Publications in Port Chester, N.Y.
Francis's advice to equity investors, including those of modest means: Be diversified among all major categories (or "styles") of equities. If that is done, he says, you should come out with profits over time.
Most stock watchers generally agree that there are at least six major categories of equities. They fall under two broad spectrums: value stocks and growth stocks.
Value stocks usually have slightly lower price-to-earnings ratios than other stocks; they are considered undervalued in the sense that they have some intrinsic characteristics that make them more valuable than they appear.
A growth stock, by contrast, may have somewhat higher price-to-earnings ratios. But the stock tends to chug ahead in adverse and benign economic climates.
Under these two broad umbrellas are the six categories, based on market capitalizations - the total market value of US companies. The six categories are small capitalization (or "small cap") value stocks; small-cap growth stocks; mid-cap value stocks; mid-cap growth stocks; large-cap value stocks; large-cap growth stocks.
Francis identifies small-cap companies as having asset values of under $1 billion; mid-cap companies overlap from $500 million to around $7 billion; and large-cap companies, $1 billion and up to $100 billion or more.
Companies that monitor stocks usually distinguish between these categories with different indexes. Thus, Standard & Poor's Corporation has the S&P SmallCap 600 index, the S&P MidCap 400 index, and the S&P 500 Composite, which is a large-cap index.
The 1995 market
In June, for example, the S&P SmallCap index rose 5.49 percent, including reinvestment of dividends; the MidCap index gained 4.07 percent. They both beat the large cap S&P 500 Composite, which rose 2.32 percent, notes Adriana Harrington, a spokesperson for Standard & Poor's. Had an investor had his money only in mid-cap stocks, or the "500," he would not have made the higher returns of the small-cap index.
The current 1995 environment, Francis says, "favors value stocks, because interest rates may now come down."
The crucial point, Francis says, is that the average spread between rates of return from different stock classes tends to be higher than the spread between different types of financial instruments.
Take 1991: Based on Paradigm's research, the difference between the highest performing stock-asset class (the S&P 500, which earned 30.45 percent) and the lowest performing asset class (the three-month Treasury bill, which earned 5.42 percent), was 25.03 percent.
But in the case of stocks, the spread between the highest performing category (Paradigm's class of small-growth stocks, which posted an annual return of more than 58 percent) and the lowest performing stock class, (Paradigm's class of large-value stocks, which had an annual return of 27 percent), was more than 31 percent.
Thus, says Francis, for equity investors it can be more important to minimize the difference in rates of return between stock classes than between types of financial instruments.
Making certain that your stocks reflect diversified categories of investing "makes good sense," says Joseph Tigue, managing editor of "The Outlook," a weekly review published by Standard & Poor's Corporation. Mr. Tigue also recommends that individuals hold some international stocks. But don't have so many stocks that you can't properly monitor them, he cautions.