Size & Value Matter

Referred to as the Fama/French 3-Factor Model, relative performance in stocks is driven by three major risk factors:
(1) Market Factor:  Stocks are riskier than bonds, and, therefore, demand greater expected returns.
(2) Size Factor:  Because smaller companies carry greater risks than larger companies, investors have higher expected returns to compensate for such additional risk.
(3) Value Factor:  Value-oriented companies (e.g. companies with low price-to-book or price-to-earnings ratios) tend to carry more risk than growth-oriented companies, which creates a greater expected return.
Identifying relevant and irrelevant risks is vital to managing risk prudently.

sizeAndValueMatter

 

The Fama/French 3-Factor Model asserts that relative performance in stocks is driven by three major risk factors:

(1) Market Factor:  The stock market is riskier than the bond market, and, therefore, demands greater expected returns.  

(2) Size Factor:  Because smaller companies carry greater risks than larger companies, investors have higher expected returns to compensate for such additional risk.  

(3) Value Factor:  Value-oriented companies (e.g. companies with low price-to-book or price-to-earnings ratios) tend to carry more risk than growth-oriented companies, which creates a greater expected return.  

Many experts feel that over 85% of stock market returns can be explained by these three risk factors. Identifying relevant and irrelevant risks is vital to managing risk prudently.  For additional information on the Fama/French 3-Factor Model, please watch the videos or read the articles located in our Library section.