We recently shared a graphic that we feels captures the importance (we’d dare say urgency) of balancing portfolios with a blend of blue chip stalwarts, medium-sized work horses and promising faster-growing smaller companies. Not the one on the right, the graphic here:

Advantage of Growth (Size) Diversification

“What about the other side? —@InvestEdInc

The ‘Too Big Of A Market Cap Stock’ Theory

Highlights:

• I don’t know about you, but have you noticed how big-cap stocks are being priced by the market? If you haven’t noticed, they are cheap.

Cheap? There’s more to “cheap” than P/E ratios. We know that P/E is just one piece of the puzzle and can be misleading or uninformative in the absence of more information. Here’s a look at our collection equally-weighted S&P 1500 components using three exchanged-traded funds from Guggenheim:

As you can see, none of the three — not even the S&P 500 — stands out with a dramatically high return forecast, even after a lost decade. The fact that all three groups have similar average growth forecasts also suggests a whole bunch of “cross pollination” these days.

• And if [lost decades are] the new norm in the large cap space — where stocks can go nowhere for years and years — why would someone want to be invested in a large cap stock over the long term, except of course for a good dividend? Also, is long-term stock appreciation not a possibility anymore with large cap stocks?

The problem was P/E compression. As Julie Werner has pointed out, Nardelli faced a lot of challenges at Home Depot (HD), but one of the bigger obstacles (from the perspective of generating superior shareholder returns as CEO) was the 40x current P/E at the time he plopped down in the CEO chair for the first time.

I don’t think lost decades are the ‘new norm’ in any stock category.

In fact, merely tendering the thought probably means that collective P/E expansion for the S&P 500 is around the corner.

Some people think it would be nice if we could just focus on the dividends. But we can’t — they’re just one piece of the puzzle too.

There’s price appreciation potential in stocks with lower growth rates. Hunt patiently.

• Assuming this totally out of the box theory of mine makes any sense, reach for smaller cap stocks and let stocks over $50 billion in market cap (or even less) for large institutional investors.

To some extent, it does. The challenge of cash deployment at Apple could very well mirror the attrition of serial M&A ten years ago at Cisco Systems (CSCO). The concepts of saturation probably apply — somewhat.

Our advice from a few months ago to hunt down faster-growing stocks can probably be tempered to shift back to an evenly distributed emphasis on smaller and larger companies. See: The Difference Between Tricks & Treats

But we stand by our time-honored recipe. All of the categories take turns leading at the dance. No one can tell you when or which partner is going to lead (and it’s certainly not obvious in those Guggenheim ETFs — at least not right now.)

In fact, we think the Guggenheim suggestion right now is shop amongst all three growth/size ranges. The return forecast stratification is as high as we’ve seen it in a while in all three classifications. Seek the highest quality companies and wait for their return forecasts to justify purchase. Hold them for as long as it makes sense to do so.