So you’re fairly new to investing and constantly see funds stating they are large cap value, small cap growth, etc. Just exactly what does this mean? Perhaps the easiest way to explain a style box was developed by Morningstar. Morningstar developed a graphical representation of a style box which is represented below.
In the picture below you can see 9 different squares within the large square. Each of these squares represents a different segment of the stock market. The large square would represent the total stock market while the smaller squares are different portions which are separated by valuation and size. In the stock market size means just how large a company is, its market cap. Valuation on the other hand has to do with how expensive a stock is measured by P/E ratio, P/B ratio, dividends, or perhaps some other combination.
Style Box Squares
- Large Value – Contains large companies which are considered fairly cheap but perhaps might not be growing as fast as some companies.
- Large Growth – Companies which are large but considered more expensive. Generally growth companies are thought to expand faster than value stocks.
- Large Blend – A blend of both large value and large growth companies.
- Medium Value – Companies which can’t be considered small or large and are fairly cheap.
- Medium Growth – Companies which cant be considered small or large but are considered more expensive with faster growth expectations.
- Medium Blend – A combination of medium value and medium growth companies.
- Small Value – Contains small companies which are considered cheap compared to other small cap companies.
- Small Growth - Contains small companies which are more expensive but may have higher growth expectations.
- Small Blend – A combination of small value and small growth stocks.
A question probably on the tip of your tongue is, “Who defines what is considered large, medium, or small cap and who defines what is considered value or growth?” The defining of these factors is left up to the particular index designer. Morningstar’s definition of a value company will be different than MSCI. Russell Investment Groups definition of a small cap company will be different than MSCI. Fortunately, no matter who designs the particular inclusion rules one constant seems to remain true. Small cap value indexes always seem to perform similar to other small cap value indexes. The same holds true for all 9 of the style box squares. Please note that this is only true for index funds and not actively managed funds.
What exactly is the benefit of all this? Each of nine squares has its own distinct characteristics. In the late 1990s large cap growth did very well at the expense of small cap value. While large cap growth stocks lagged in recent years small cap value stocks have done great. Essentially this will allow us to construct a portfolio that will do well in all situations.