Does Eliminating Unprofitable Small Caps Improve Long Term Small Cap Index Performance?

Core Insights - The article discusses the performance comparison between the S&P 600 and the Russell 2000, emphasizing the impact of profitability on investment returns [11][28]. - It highlights that the S&P 600, which requires companies to be profitable, has consistently outperformed the Russell 2000, which includes a significant number of unprofitable firms [10][14][28]. Group 1: Performance Comparison - The S&P 600 has shown better performance over various time frames compared to the Russell 2000, with most one-year, five-year, and ten-year rolling returns favoring the S&P 600 [14][19][22]. - Historical data indicates that investing in the S&P 600 for any ten-year period over the past 31 years would yield positive returns [26][28]. - The S&P 600's requirement for positive GAAP earnings contributes to a higher quality of aggregate earnings and cash flow, leading to improved returns [28][30]. Group 2: Investment Strategy - A systematic investment strategy that focuses on high profitability stocks can yield better returns compared to a strategy that includes low or non-profitable stocks [5][11]. - The article suggests that a diversified basket of profitable stocks can provide stable cash flow and high yield, akin to a long-term fixed income investment [7][8]. - The performance of the Russell 2000 is negatively impacted by its higher proportion of unprofitable companies, which dilutes overall returns [10][14].