S&P 600

The S&P 600 (also known as the S&P SmallCap 600) is a stock market index that represents the small-cap segment of the U.S. stock market. Maintained by Standard & Poor's, it tracks the performance of 600 small American companies selected for their growth potential and financial viability. Unlike many other indices that are sorted purely by size, the S&P 600 has a special “velvet rope” policy: to get in, a company must be profitable. Specifically, it must have posted positive earnings not only in its most recent quarter but also over the sum of its last four quarters. This simple quality filter is a game-changer. It kicks out the speculative, cash-burning startups and focuses on established, profitable businesses. For investors, this means the index is tilted towards higher-quality companies, a feature that aligns wonderfully with the principles of value investing and has historically led to stronger performance compared to its more famous peers.

The secret sauce of the S&P 600 is its profitability requirement. Think of it as a bouncer at an exclusive club. Many companies might be the right size to join the small-cap party, but if they aren't making money, the S&P 600's bouncer says, “Sorry, not on the list.” This criterion ensures that the index is composed of businesses with a proven ability to generate profits. This is a fundamental concept straight from the playbook of Benjamin Graham, who taught that investing should be approached like a business operation. By weeding out unprofitable firms, the index avoids many of the riskiest bets in the small-cap space, focusing instead on resilient enterprises. Other criteria for inclusion include adequate liquidity and public float, ensuring the stocks can be traded without major price distortions.

When people talk about small-cap stocks, the Russell 2000 index is often the first name that comes to mind. It's the most widely cited benchmark for small-cap performance. However, there's a crucial difference in how the two indices are built.

• The Russell 2000: This index is a pure-play on size. It simply takes the 1,001st to the 3,000th largest U.S. stocks by market capitalization. It doesn't care if they're profitable or not. As a result, a significant portion of the Russell 2000 is often made up of money-losing companies.
• The S&P 600: As we've seen, it insists on profitability.

This single difference in methodology has led to a notable divergence in long-term performance, with the S&P 600 often outperforming the Russell 2000. For investors, this is a powerful lesson: quality matters, especially when you're playing in the often-turbulent small-cap arena.

While a value investor's primary focus is on analyzing individual businesses, the S&P 600 offers a compelling framework and a useful tool.

A dedicated value investor typically avoids buying an entire index. The goal is to find specific, wonderful businesses at fair prices, not to buy the whole market. However, the S&P 600 can be seen as a pre-screened fishing pond. It provides a list of 600 profitable, smaller companies that are often overlooked by Wall Street analysts. This makes it an excellent hunting ground for discovering mispriced securities. An investor can use the list of S&P 600 constituents as a starting point for their own deep-dive research, confident that the initial “is this a real business?” test has already been passed.

Value investors are often drawn to small-caps for two key reasons:

• Inefficiency: Fewer analysts cover these stocks, meaning there's a higher chance the market hasn't priced them correctly.
• Growth: Smaller companies have more room to grow than giants like Apple or Microsoft. Finding a great small business early can lead to spectacular returns.

However, small-caps also carry higher risks, including greater price volatility and lower trading liquidity. The S&P 600's quality screen helps mitigate some of this risk, but it doesn't eliminate it.

For those who prefer a more hands-off approach, buying a low-cost Exchange-Traded Fund (ETF) that tracks the S&P 600 can be a smart way to gain exposure to a diversified basket of quality small-cap stocks. It's a form of passive investing, but one that's tilted toward a key value factor: profitability. It represents a more intelligent, quality-focused alternative to broader, market-cap-only small-cap funds.

• Definition: The S&P 600 is a U.S. stock market index of 600 small-cap companies.
• The Secret Sauce: Its key feature is a profitability screen, requiring companies to have positive earnings before they can be included.
• Quality Over Quantity: This quality filter distinguishes it from other indices like the Russell 2000 and has historically contributed to better long-term performance.
• Value Investor's Tool: It serves as an excellent, pre-vetted list of potentially undervalued companies for further research or as a basis for a quality-focused ETF investment.