O'Shaughnessy's Tiny Titans Screen: A small-cap value and momentum strategy

Sunday, Feb 12 2012 by
9
OShaughnessys Tiny Titans Screen A smallcap value and momentum strategy

In Brief

Tiny Titans is a small/micro-cap strategy developed by O'Shaugnessy in his 2006 book, "Predicting the Markets of Tomorrow". It looks for cheap small caps with upward price momentum.

Background

James O'Shaughnessy is an American investor and the founder and CEO of O'Shaughnessy Asset Management, (OSAM), an asset management firm headquartered in Stamford, Connecticut. O'Shaughnessy wrote the seminal 1996 book "What Works on Wall Street” where he set out his renowned Cornerstone Growth and Cornerstone Value strategies, which we've discussed and modelled elsewhere. 

In his earlier work, O’Shaughnessy avoided micro cap strategies but, in his 2006 book, "Predicting the Markets of Tomorrow", he argues that markets move in 20 year cycles and, because of the principle of mean reversion, the next 20 years is most likely to favour small-caps: "The best returns will likely come from the stocks of small-size companies, mid-size companies, large company value stocks, and shorter duration, intermediate-term bonds". 

He also noted that tiny micro-cap stocks have several unique features that make them ideal for aggressive investors:

  1. As with small-cap stocks, it’s virtually impossible for Wall Street analysts to give adequate coverage to micro-cap stocks. It’s not worth their time to do deep research on such a large number of tiny-cap stocks, which makes the market imperfect and with considerable potential upside.
  2. Second, micro-cap stocks have lower correlations with other capitalization categories. While small stocks in general have an average correlation with the S&P 500 of 0.74 between 1952 and 2004, micro-caps have an even lower correlation of 0.66. This means that they offer diversification benefits.
  3. Finally, micro-caps are extremely volatile and best suited to investors willing to accept dramatic ups and downs in their portfolios.

Criteria

Tiny Titans is the most "aggressive" of his small-cap strategies. The criteria are quite simple:

  • Market cap of $25 to $250 million (£15 - £150m assumed in a UK context)
  • Price to sales below 1
  • Minimum liquidity - When describing the universe of liquid stocks, O’Shaughnessy puts the minimum at $500,000 traded per day. 
  • From this list, the idea is to take the top 25 sorted by 12 month price appreciation and equally weight them.

Does it work?

From 1951 through 2004, the strategy had a real (i.e. above inflation) average annual  return of almost 19%. turning one dollar invested in 1951 into $9,734.85 by the end of 2004. In contrast, a small-cap index offered a real average annual…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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