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Small Caps vs Blue-Chips: Which Should You Buy?

While investing for the long run can be a very worthwhile pursuit, there are many different styles of investing, sectors to invest in, and a wide range in size of companies that you can buy. At the larger end of the scale is the FTSE 100, which includes some of the biggest and well-known companies in the world. This is followed by the FTSE 250, then the remainder of the FTSE All-Share and AIM, where the companies tend to be much smaller (although there are exceptions on AIM).

Stability

Of course, there are pros and cons regarding different sizes of companies. For example, larger companies tend to be more mature and offer greater stability than their smaller peers. They have often been in existence for decades and have built a highly efficient supply chain, have a management team with an excellent track record, and have developed significant customer and brand loyalty so that their products are leaders in their field. As such, the chances of them ceasing to trade are very low and, over time, they are likely to offer strong and reliable returns.

In contrast, smaller companies are often much younger and do not have the same financial strength or track record of profitability. In addition, they are often more dependent upon a smaller number of customers, and so can be susceptible to challenges when they lose a significant client. Furthermore, smaller companies are generally less diversified (both geographically and in terms of their products) and this can leave them more vulnerable to a tough economic climate that their larger peers can better cope with.

Growth Potential

Of course, smaller companies can offer greater rewards than larger companies. Their less mature status can mean that their top and bottom lines still offer a much faster rate of increase and this can catalyse investor sentiment and push their share prices much higher. In addition, smaller companies are more nimble than their larger peers; decisions can be taken more quickly and they can adapt much better to changing circumstances, a change in client tastes, or an opportunity in a similar space to that in which they currently operate.

Other Considerations

Because smaller companies are less covered by institutional investors/analysts, the information available to investors is reduced compared to larger companies. This is especially true of AIM stocks, for which the disclosure requirements differ to those of the FTSE All-Share. As such, this can be something of a double-edged sword in terms of offering greater scope for undervalued opportunities, but also a greater risk that there are known unknowns in a company’s offering.

In addition, the spread on smaller companies (i.e. the difference between the price at which you buy and sell) is significantly wider than for larger companies. This is an additional cost for investors, while lower levels of liquidity can make selling shares in smaller companies more difficult than for their larger peers – especially if you are investing sizeable sums of money.

Balanced Approach

However, there are clearly opportunities in both spaces (and in between via mid-caps) and so a sensible strategy could be to own a mix of small, medium and large companies. That way, you can neutralise their weaknesses to a degree. Furthermore, you also stand to benefit from the relative stability of blue-chips, and yet also tap into the upbeat growth prospects of their smaller peers.

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