Small Minus Big (SMB)

What Does Small Minus Big Mean?

Small minus big (SMB) is one of the three factors in the Fama/French stock pricing model. Along with different factors, SMB is utilized to make sense of portfolio returns. This factor is likewise alluded to as the "small firm effect," or the "size effect," where size depends on an organization's market capitalization.

Seeing Small Minus Big (SMB)

Small minus big is the excess return that smaller market capitalization companies return versus larger companies. The Fama/French Three-Factor Model is an extension of the Capital Asset Pricing Model (CAPM). CAPM is a one-factor model, and that factor is the performance of the market as a whole. This factor is known as the market factor. CAPM makes sense of a portfolio's returns in terms of the amount of risk it contains relative to the market. As such, as per CAPM, the primary clarification for the performance of a portfolio is the performance of the market as a whole.

The Fama/Three-Factor model adds two factors to CAPM. The model basically says there are two different factors notwithstanding market performance that reliably add to a portfolio's performance. One is SMB, where in the event that a portfolio has all the more small-cap companies in it, it ought to outperform the market long term.

Small Minus Big (SMB) versus High Minus Low (HML)

The third factor in the Three-Factor model is High Minus Low (HML). "High" alludes to companies with a high book value-to-market value ratio. "Low'" alludes to companies with a low book value-to-market value ratio. This factor is likewise alluded to as the "value factor" or the "value versus growth factor" since companies with a high book to market ratio are commonly thought of "value stocks."

Companies with a low market-to-book value are commonly "growth stocks." And research has exhibited that value stocks outperform growth stocks over the long haul. Thus, over the long haul, a portfolio with a large extent of value stocks ought to outperform one with a large extent of growth stocks.

Special Considerations

The Fama/French model can be utilized to assess a portfolio manager's returns. Basically, in the event that the portfolio's performance can be credited to the three factors, then the portfolio manager has not added any value or exhibited any expertise.

This is since, in such a case that the three factors can totally make sense of the portfolio's performance, then, at that point, none of the performance can be credited to the manager's ability. A decent portfolio manager ought to add to a performance by picking great stocks. This outperformance is otherwise called "alpha."

Researchers have expanded the Three-Factor model in recent years to incorporate different factors. These incorporate "momentum," "quality," and "low volatility," among others.

Highlights

• Past the original three factors in the Fama/French model — the SMB, HML, and market factors — the model has been expanded to incorporate different factors, like momentum, quality, and low volatility.
• Small minus big (SMB) is a factor in the Fama/French stock pricing model that says smaller companies outperform larger ones over the long-term.
• High minus low (HML) is one more factor in the model that says value stocks will generally outperform growth stocks.