Small caps have beaten large caps over the last ten years, but fleas aren't always better than elephants.
Jim Slater once said that elephants don't gallop. He implied that big companies may often struggle to grow because opportunities to expand may be limited. By contrast, it is reckoned that fleas can easily jump ten times their own height. The suggestion here is that investors may reap higher rewards by investing in small companies.
But which are the better investments, fleas or elephants?
According to the relative performance of the FTSE Small Cap and the FTSE 100 indices, the former has probably been the better investment. Since 1 January 1996, the FTSE Small Cap Index has risen from 1,946 points to 3,451 points, which equates to a 77% improvement. By comparison, the FTSE 100 has risen from 3,687 points to 5,837 points. This equates to an improvement of 58%.
But that is not to say that all large caps have languished. You can't ignore the exceptional rise of mining shares in the last five years. Since 2001, BHP Billiton
(LSE: BLT)
has jumped 286% to 936p, and Xstrata
(LSE: XTA)
has surged 268% to 2,268p. Tobacco companies that include British American Tobacco
(LSE: BATS)
and ImperialTobacco
(LSE: IMT)
have also risen considerably as they expand into new markets. And in what is generally regarded as a quiet sector, household cleaner maker Reckitt Benckiser
(LSE: RB.)
has soared 131% to 2,125p since 2001.
Meanwhile, Small Caps have had their fair shares of losses. Pub group Regent Inns
(LSE: REG)
is down 54% on disappointing trading, and Pace Micro Technology
(LSE: PIC)
, which makes digital set top boxes, has lost 44% of its value. Other notable laggards include consumer electronics maker Alba
(LSE: ABA)
, which is down almost 50%, and clothing retailer Alexon
(LSE: AXN)
has fallen 19%.
As I see it, the size of a company is almost irrelevant when it comes to investing. What matters is whether a business has a meaningful competitive advantage. It should also have a conservative balance sheet, which means low or manageable debts. It also helps if the company can demonstrate a track record of success over the years.
But what generally happens is that smaller companies tend to be under-researched by professional investors. Consequently, they are more likely to be undervalued than larger companies because news also tends to be sparse. However, there is a downside to consider, too. Since trading volumes may be thin, the shares can be volatile, which may not suit all investors.
So which is better?
By and large it is perhaps easier for a small company to surprise investors by doubling its turnover and profits than it is for a large company. And since share prices tend to follow profits, it is not inconceivable for a small company's shares to double. But remember, not all surprises are pleasant ones!
