Big things are awesome. Just look at my penis. LADIES ONLY. Okay, you can too fellas. I’ll let everyone bask in the awesomeness. You know what else is awesome? Investing in small cap stocks. And my ass.
When it comes to investing, big stocks often get all the attention. Apple is more worshiped than Jesus and Allah put together. Dividend growth investors splooge over Johnson and Johnson. And hell, I’m sure we can all agree that the potato chips made by the snack division of Pepsico are better than kittens mixed with rainbows. Large cap stocks get all the attention, mostly because they’re big enough that they’re involved in our lives somehow.
Often, when investors look for individual stocks to invest in, they don’t look past the biggest of the big companies. People seem to think that large cap stocks are somehow safer, that they won’t go down in price. They also think that large companies are less likely to go bankrupt, kinda like Nortel, General Motors, Washington Mutual and Enron all avoided bankruptcy. Oops.
These days, when I do my research on picking stocks, I’ll often put an upper limit on the market cap when I use a stock screener. (usually $500M for Canadian companies and $1B for American companies) I’m looking specifically at investing in small cap stocks, and I think you should too. Here’s why.
Less Competition – Analysts usually stick to large cap stocks. Traders usually stick to large cap stocks, mostly because of size and liquidity. Most investors stick to large cap stocks, because of the perceived safety. What does this mean for you? It means you get your pick of the litter.
Think about it as hitting on the plain girl at the bar. Sure, she might not be as sexy as her friends, maybe her boobs aren’t as big. But as you keep talking, you realize that she’s smarter, funnier and has some really neat interests. If you were over talking to all the hot girls, you never would have found the diamond in the rough. This exactly how you’d be investing in small cap stocks. FINALLY, A HOT GIRL/INVESTING REFERENCE ON FINANCIAL UPROAR.
Less competition is a good thing as an investor. It allows you go get in on the bottom floor of good growth stories. It allows you to buy profitable companies for 50-75% of book value. It allows you to buy break-even companies for less than the cash on the balance sheet. Why haven’t all sorts of other investors scoped out these bargains? Because they don’t know these companies exist.
Better growth potential – Apple is the granddaddy of all stocks. It has a $600M market cap, sells like 10 million devices every quarter (all at a few hundred bucks a pop) and I’m pretty sure it could beat up every other stock in the S&P 500. It is a giant behemoth, but we’ll all tell it that its ass totally doesn’t look fat in those jeans.
Apple needs to come up with blockbuster products to keep growing their revenue and profits. If you were ever going to buy an Apple product, chances are you’ve already bought one. Or six. At some point, they’re going to run out of magic and start the long, slow descent to mediocrity. I will laugh heartily when this happens, mostly because I’m a jerk who laughs at other people’s pain.
What company is easier to grow – the one with $100M in annual revenue, or the one with $108B? Sure, there are a lot of variables involved, but if all things are equal, it’s the smaller company. A smaller company can also easily exploit inefficiencies or find business that a larger competitor just might not bother to pick up.
Management – Most of the time, I really couldn’t care less how much a company pays a CEO. When you compare the size of a CEO’s pay package (aside: giggity) to the size of the company, it’s usually small potatoes. Managers of small cap stocks get paid less, but it’s usually a comparable percentage. Still, it is nice not to see a CEO get tens of millions of dollars in severance when he gets whacked.
Often, management of small cap companies own significant chunks of the company. As an investor, you should love this. If management owns a big chunk of the company, they’re just as motivated to increase the share price as you are. They’re also more likely to make good long term decisions, rather than just focusing on keeping their job. When I look at potential stocks, small cap names with large management ownership stakes get bonus marks.
Better capital gain potential – Most small caps trade under $5 per share. This is one of the things that scare off regular investors, since penny stocks always = crazy risk. Nothing could be further from the truth.
Like with any stock, small caps must first be analyzed. If you’re buying $1 worth of assets for 50 cents. (which is much more likely to happen with a small cap stock) that automatically gives you a giant safety zone. If the company is profitable as well, that’s always good, and so is a dividend. A low stock price doesn’t automatically make a company risky, it always comes down to fundamentals. I feel like a basketball coach.
Mutual funds don’t own them – Wait, what? Why is this a good thing?
Often, when a large cap stock gets beaten up, mutual funds will dump the stock, because they’re kind of uniquely good at the whole buying high and selling low thing. When their quarterly reports come out, they don’t want to show that they’re holding the latest stock to hit the crapper. So they sell it, “window dressing” the portfolio to look better.
Small cap stocks, on the other hand, only have one direction to go, and that’s up. If they ever go on a nice run and get picked up by a few mutual funds eventually, that would be a huge bonus for the stock and for the shareholders.
Just do it already. I’m bored.