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Investing in Small-Cap Stocks Why We Will Always Love Small Caps
When I first got interested in stocks, I was handed a copy of Tweedy, Browne’s “What Has Worked in Investing.” This is a wonderful summary of various studies aimed at explaining why certain areas of investing work better than others. It encompasses research dating back to 1926 when record keeping started on these kinds of stats. In the report, they organize the data into five categories, or characteristics, of investing:
I want to focus on the third and the last of these characteristics. Now obviously, you believe to at least some degree that small-cap companies offer better gains than their larger contemporaries, or you probably wouldn’t be reading this, but I’m willing to bet that you didn’t know how great the difference is between the two groups. Take a look at the chart the report provides us on a study of 10 deciles of different market caps between 1963 and 1980:
As you can see, as the size of the companies in each group gets smaller, the returns are greater. There are many reasons for this… The most obvious is the simple fact that it doesn’t take much price movement to double an investment on a true penny stock ($0.01 to $1) as it would for a true blue chip ($50-plus). Another fairly obvious explanation for small-cap success is mobility. It’s extremely easy for smaller companies to refocus certain aspects of their business plan. They can also move around in their industry finding the best niche market to exploit. This improves their profit margins compared to larger companies. The last reason that I’ll give today for why small companies perform better has to deal with the overall cost of owning a portion of the company. We’ve said it before, and I’m sure we’ll say it again… Smart investors look at their investments as pieces of companies instead of just shares. It is far easier for people to buy up larger chunks of small companies, which will raise the stock price. Here, I want to note that the most successful businesses have this happen all the time by their own insiders (directors and officers). Smaller companies benefit more from this than larger ones because these insiders can actually control more ownership of the company with less money. Insider buying, as well as share repurchase plans, can drastically move a small company’s share price, which benefits everyone. There are hundreds of other reasons for why small companies perform better, but the point is they just do. It’s important for investors to take a look from time to time at why they invest the way they do. And for us in the small-cap world, it seems far too easy to confirm why we like these types of companies… The proof is in the past. Sincerely, P.S.: We are always looking for small companies that are buying back shares, or have insiders buying up large chunks of shares, because these are usually the most successful small-caps. We just found one that is both buying up shares, and has a new CEO that recently purchased a bunch. We are extremely excited about the potential for this company. In fact, Greg “Gunner” Guenthner, head of Penny Stock Fortunes, is so excited that he’ll be sending his readers a special “buy alert” tomorrow. If you agree that insider buying and share repurchase plans are the way to go and you would like to find out more about Gunner’s new pick, then you should read this free report and sign up for his penny-stock-picking service. Check it all out here… |
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Jim Nelson is the managing editor of Penny Sleuth, a daily small-cap e-letter with more than 110,000 subscribers. Jim has been playing the stock market since he was 14, always with a preference toward smaller companies. He has honed his stock picking skills at Agora Financial since 2004, effectively combining a growth and value approach. He holds a degree in Political Science with a minor in History from the University of Pittsburgh. |
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