Investment Corner: When bigger is not better
NVIDIA. Google. Apple. Microsoft. These are names of companies that everyone knows. With valuations in excess of 1 trillion dollars, these “mega-cap” companies are known by investors everywhere. But does being big make a company a better investment?
Publicly traded companies are generally classified by size as either small-cap, mid-cap, or large-cap. “Cap” stands for capitalization, or the value of the company’s outstanding shares. Per Investopedia, small-caps are typically defined as companies valued between $250 million and $2 billion, mid-caps are usually between $2 billion and $10 billion, and large-caps are worth $10 billion or more.
Many investors almost exclusively own large-cap companies. For example, the S&P 500 Index is very often cited as a savvy investment, but it is made up of 81% large-cap companies and 19% mid-cap. Zero small-cap. Large-cap stocks tend to be the most recognizable companies, of course, and so it feels safe to invest in them. However, remember that all of them were small-caps at some point. If you were lucky enough to invest in Apple when it was a small-cap stock, you are likely a multi-millionaire right now!
There’s nothing wrong with large-caps, by the way. They’ve actually given investors the best returns overall during the past decade, and solid returns for a century. But look a bit further into the numbers, and you will see that small-cap outperformed large-cap in approximately 2/3 of rolling 10-year investment periods since 1927, per Dimensional Fund Advisors. That’s nearly 100 years of evidence! And, during that same period, small-cap stocks outperformed large-cap stocks by almost 2% when returns were compounded annually.
Of course, higher expected returns come at a cost. Modern Portfolio Theory tells us that we generally need to take more risk in order to expect higher returns. Small-cap stocks—wouldn’t you know it—on average carry a higher level of risk than do large-caps. So, while we want small-cap stocks in our portfolio, we don’t want them to dominate our portfolio. Rather, we want to hold a big enough chunk of small-caps in our portfolio to improve expected returns without raising our risk level too high.
What is a good investor to do, when large-cap stocks have been hot for a decade-plus, but small-cap stocks have outperformed for 100 years? The same thing you always hear in this column: build a diversified, resilient portfolio with pieces of small, mid and large-cap stocks. From one year to the next, it’s impossible to know which part of the market will outperform the others. Just don’t forget to include small-caps, they can really make your portfolio sing.
However you choose to build your portfolio, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
