06. SMB

SMB

To create a theoretical portfolio representing size, we could go long the bottom 10th percentile of stocks by market cap (long small cap stocks) and go short stocks above the 90th percentile (go short the large cap stocks). We could assume an equal dollar amount invested in each stock. In the above example, we are dividing by 2 to take the average return of going long small cap stocks and going short large cap stocks.

It's also common to compute the spread between two portfolios. One portfolio contains the small cap stocks, and the other portfolio contains the large cap stocks. In this case, we'd just take the difference between the returns of the two portfolios.