We compare the median returns of private equity against simulated micro-cap portfolios of 20 stocks that are selected from the cheapest 5% and the most profitable 5% of companies within each year. Within our micro-cap data, there are typically 30-50 stocks in the top 5% of any given year, and the factor-ranked simulations randomly select from this opportunity set when forming the 20-stock micro-cap portfolios over the course of three years (at a pace of 6-7 investments per year). For context, there are over 2.3 million businesses with more than five employees in the United States. So if the private equity industry focuses on the top 5% of that universe, the PE opportunity set would have plentiful investment targets, with over 116,000 firms. This target list represents more than 6x the 18,000 firms actually owned by PE today. Therefore, we believe our 5% sampling provides a good representation of the opportunities available to PE. Value characteristics appear to have the biggest impact on micro-cap returns, boosting the median return from 10% in a totally random sample to 18% in a value-ranked sample of 20 stocks. Quality also seems to matter, with an improvement of 4pp in the median return from 10% in a totally random sample to 14% in a profitability-ranked sample of 20 stocks.
- Date Posted:
- December 11, 2023
[Keynes observed] "Anything we can actually do we can afford." But Keynes was wise enough to understand that the inverse was also true. We cannot afford what we cannot actually do: "[We must] prevent a demand in excess of the physical possibilities of supply, which is the proper meaning of inflation. For the physical possibilities of supply are very far from unlimited." Keynes did not believe that governments could spend whatever they wanted on welfare, nor did he believe that societies could build whatever public works they desired without concern for the cost. Rather, he believed in the importance of respecting limits and investing in productive capacity to change those limits. Economies that are not self-sufficient—almost all, with the possible exception of NAFTA—need to develop dynamic export industries to pay for needed imports. Argentina has essentially followed the reverse of this advice and paid the price.