Do big companies make better investments than small ones?
Some of the most successful investors swear by small caps whilst others eschew them as unreliable and maybe even untrustworthy. Like most things in life, there are pros and cons to consider.
The phrase "elephants don't gallop" was coined by investor and writer Jim Slater when he compared the slow earnings growth of big cap companies to elephants. He also likened growth of some smaller businesses to fleas which can jump over two hundred times their own height. And on this basis, small caps definitely offer a lot more excitement. But there are downsides.
The cap's too tight?
Of course, small caps are often the cheapest on the various value components we may look at such as P/E, PEG, PSR, PCF, PTBV, and the like. But can you trust the figures? And can you trust the companies? You may buy having done all the research you can in the hope that these fantastic fundamentals will be recognised and the share price will react accordingly. And they often do. But sometimes something comes along from out of the blue to knock a small company sideways -- or maybe even K.O. it altogether, notwithstanding some of its tempting potential.
Similarly, brokers' forecasts aren't usually as accurate for small caps where there may be only one or two brokers looking at a stock -- and even then giving it less detailed attention that they would an "elephant" where their reputation is far more at stake.
Also, brokers often have a vested interest in being overly optimistic for small caps.
And that's not the only area where there's less attention. Small cap company directors may act like the company is a private fiefdom. And, let's be honest, there's more room for unscrupulous behaviour.
Then there are the crazy small company share price movements which bear no relation to how a company is performing. Often, good news and an initial share price hike can be followed by a wave of selling by shareholders looking to bank a profit, and the price reacts accordingly.
The cap's too loose?
On the other hand, recent events have shown us all too painfully that very big cap companies can behave unwisely. There will always be bear markets, but the seismic shifts in financial markets of the last couple of years and the behaviour of many large financials in the preceding years do nothing for private shareholders' confidence in big caps. On the flip-side of the same coin, there are small caps which are profitable and are near to, or sometimes even below, cash value, with other assets to boot. Are these situations riskier than, say, major financial blue-chip but indebted institutions? This is a matter for personal judgement, but whatever else happens, if a company has a strong balance sheet with bags of cash, it won't go bust.
Similarly, illogical price movements can present buying opportunities if you have long term confidence in a small cap.
The beauty of small cap stocks -- aside from their flea-like ability to accelerate -- is that they're much quicker and easier to research, and there are far fewer people doing that research, including brokers, so you're much more likely to unearth a gem. Whereas, with a big cap there armies of analysts continually poring over every detail. That isn't to say there aren't pricing anomalies now and again with the big caps, but these are usually based on sentiment rather than fundamentals.
So which cap fits best?
Generally speaking, your cap-size preference depends on how willing you are for your investment to capsize. The lower the risk profile you desire, the larger the companies you're going to want to be invested in on the whole.
And for most people, the nearer you are to retirement age, the more risk averse you're going to want to be. Investing in elephants will usually generate steady returns while you relax. But it also depends how far you want to go in doing your own research and staying on top of developments in small cap companies. If you're a more active investor willing to accept a slightly higher risk-reward profile, then a smaller cap is a lot more exciting.
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