E166: $20 Billion CIO: Why Small Cap Stocks Have Underperformed (and why that’s unlikely to change) w/Brad Conger
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What are the key insights on small-cap stocks?
And then there were permanent residents, meaning sort of companies that just trundled along and never really grew. I think those last two baskets of small cap have increased dramatically. And the reason is that I think the PE industry, by keeping companies under advisement longer, has truncated the ability of the small cap index to capture growth in entrepreneurial capitalism at an earlier stage. And so I think those numbers were fine as they were computed. I think that the index has changed over time. So historically, the small cap were just smaller, higher growth companies, similar to the large cap companies. Today, they're just fundamentally different businesses. They're fundamentally adversely selected. Double click on the types of small cap companies that you see in the market today, 2025.
There's a meme out there that something like 40% of the Russell 2000 companies have an EBIT less than their interest expense. In other words, they're zombie companies. I don't know if that number is really true or not, but it's clear that the default risk, the bankruptcy risk in small cap stocks has dramatically escalated. The debt to equity is much higher than it has been historically. So I think that is one of the consequences of this, you know, PE taking the growth out of the public markets. To double click on that, not only do you have these companies that are poorly capitalized, but the good companies are staying private. So it's not only that there's bad companies that are public, it's also the good companies are not going private. It's two different factors that are affecting the small companies.
So Klarna, when it comes out, will be a $40 billion company. I would assert that 20 years ago, 15 years ago, Klarna would have been an IPO and it would have been IPO'd in the small cap zone, something less than $10 billion. It's leapfrogging that whole class of companies and it's going straight to, it'll be in the S&P index within six months. And this phenomenon is not only going on with private equity companies, it's also going on, Klarna is also venture-backed. So the quality of small public companies on both potential PE targets and VC targets is also lower quality than it would be before. In other words, companies are just staying private longer in both PE and venture. Absolutely. It's more attractive for managements to basically work for KKR and live in that ecosystem where they can graduate to larger portfolio companies over time. They don't have to worry about the public communication. So, yes, I think that
Not to disparage small caps unnecessarily, but I think it's comprised more of companies that have to be there rather than companies that want to be there. The companies that have a choice stay in the PE ecosystem longer.
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Chapters
2 chaptersSpeakers
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