Are small cap stocks better than large cap stocks?
I just thought about this topic this morning and decided to make a quick post about it. A lot of people say that small caps are better than large caps but is this really true?
First of all I believe that it is bad to generalize because not every company has the same quality or represents a great investment opportunity. Regardless of it’s market cap
But there is one big advantage small caps have over large caps and thats what I wanted to talk about today.
The big advantage small caps have is that :
Less people are looking at small caps. So there is a higher chance that there are overlooked opportunities
Let’s be serious. How can we expect to see something the market doesn’t know already about a massive company like apple
Millions of people are looking at this stock. Tons of analysts write endless research papers. People discuss the stock on the financial news every day. How can we find something that most other market participants don’t know already? I would say thats close to impossible,
Quick side note : to do average returns in investing we also don’t really need to know more than others. We can just go with the flow and invest alongside all those people. But your plan is to outperform right?
With most large caps we don’t really have an advantage over the market
This is why some people like small and micro caps.
Small cap stocks have barely any big institution looking at them. There are a few reasons for this:
First of all they are too small so they can’t invest in them to begin with. Then analysts also rarely cover them because there aren’t many fees to be made. Thats the sad truth of it. Analysts don’t cover things where they can’t earn money on. It’s not like people spend time and resources to do retail Investor a big favor.
But this can be good for the individual investor. If nobody is looking at these companies then there is a high chance that some amazing smaller companies are undervalued.
And keep this in mind. Most companies don’t have to stay small. These companies earn money. They can grow and eventually become more interesting for big players.
Thats a great chance for us as individual investors. We can discover smaller companies that offer a great opportunity for outsize returns.
Of course there are also problems with small caps:
One big issue is liquidity and it can hurt two ways. First not many shares might be trading so many people can not build meaningful positions
Second there could be a lot more Volatility than with large caps.
Someone might be doing a fairly small transaction for non fundamental reasons and it could move the price of the stock simply because the shares were illiquid at the time of transaction
Here is a sample. If you have a company thats maybe trading only $250,000 in daily volume then someone could move the price by buying or selling let’s say $50,000 worth of stock during an illiquid time. Many times This don’t have to do anything with the value of the company and the person doing the transaction has their own reasons BUT of course the stock would move sharply.
A lot of people don’t like this kind of volatility.
I think when it comes to small and especially micro caps you can only be succesful if you really think as an owner of a company.
If you know what this company is really worth then you don’t have an issue if its volatile. In fact you might welcome it because you can load up on more shares when the price drops sharply for non fundamental reasons.
The low liquidity also creates another issue:
Big firms aren’t interest in investing in it because this company wouldn’t move the needle
The liquidity is low so they could not even put 1 million dollars to work without moving the price themselves.
so big firms will not come in until this company grows But that doesn’t need to stop you as an individual investor. you have a great company here and you could put some money to work
This can be especially profitable if you identified a catalyst that will put your company on the map
You might notice that they’re closing some interesting deals or that they are launching some new products that are in high demand
These things can make your small cap more interesting for other investors
because in the end one thing is true:
The price of a stock won’t go up unless others bid up the price of the shares.
I hope you found some value in this blog Post. Please let me know in the comments if you prefer small or large caps
Btw I also made a video version of this blog post. You can check it here: