Small but mighty. We often hear this said about people who are petite. That just because they aren’t tall(er) doesn’t mean they aren’t as cool! But, guess what? It’s exactly the same when it comes to the stock market. Investors love those big mega caps. They can’t get enough of them; nor can the research analysts (the folk who delve into these companies).

After all, they’re the ones who produce the buy/sell recommendations on companies and the more well-known a company is, well, the more they’ll be covering it. That’s a given. It’s the FTSE 100 stuff, the S&P 500 constituents and so on. It’s your Apple and your Microsoft. It’s the big guys. They get all the attention. After all, why bother covering a tiny company no one’s even heard of, let alone invested in!

Mega caps are also super liquid and they have way higher trading volumes than, say, your small caps. As a trader/investor, you’re able to buy a whole lot of a mega cap stock before you alter its price. But for small caps, the reality ain’t quite the same. You get to trade a far thinner volume and they aren’t nearly as liquid as the bigger ones. 

The big guys grab all the attention  

Most people want to know what’s going on with the big caps. You read about Facebook (now Meta) and their ‘metamates’ or Microsoft’s mega deal. This is precisely the kinda stuff that gets all the (investment) attention. It dominates the media. Not the obscure small caps. You’ll hardly ever read about that in the news. 

For this reason, there are hardly any sell-side analysts (analysts who produce reports on why investors should sell a particular stock) since there’s not much incentive to produce such reports if not many are holding the stock to begin with! Let’s not forget that small caps (compared to mega caps) are riskier so more people tend to hold less of this stuff and more of the less risky stuff (like mega caps). 

All of this means that when it comes to investing, these small caps (but potentially more powerful) don’t get nearly as much as attention as the rest which is why it can be extremely lucrative for fund managers to focus on these smaller companies. The companies that don’t quite get all that attention and buzz. But hopefully will do, someday down the line.

They’re basically searching for gold in places people aren’t even looking in. Bigger chance of success, right? The big caps are so saturated. They’re frankly overcrowded that it’s so hard to outperform in this area. But when it comes to small caps, since they’re not nearly as researched, it’s very possible to generate outperformance. 

And I quite like the idea of investing into companies that aren’t widely covered. The small cap universe is filled with all sorts of names you’ve probably never heard of! And that’s a good thing. It means you’re investing in areas that others aren’t. And you know what I’m gonna say – the less crowded, the better! 

Active fellas …..

When it comes to investing into small caps, I do not use a passive investing route (investing in broad markets like the FTSE Small Cap Index where your return mimics the market) for the exact reason that small caps, as an industry, is not that widely covered. So, I happily place my faith in fund managers to do all the hard work and find the gems hidden among the thousands and thousands of non-gems. (Read here the 3 best, most accessible ways to make money while you sleep!)

There are times when active investing is better (like investing into emerging markets and small caps, for instance) and there are times when passive investing is a whole lot better (for global stocks and mega caps). Passive and active investing don’t need to be contradictory. It’s not one or the other. You can have both. Because, in my mind, they serve very different purposes. So, mix and match. And watch your diversification soar. Because diversification is as much about investing into different areas as it is using different investment styles.

Every mega cap out there started out as a small cap. Every Apple began as something far, far smaller. And this is what small cap fund managers are looking for. The next growth story. The next Apple. The next Tesla. And you certainly aren’t gonna find it in the land of the big and mighty. They’ve grown. They’ve delivered stunning share price returns. And now they’re stable, solid and sound companies. But they’re not your whopper growth stuff. The smaller companies will be that. 

I met with the owner of a fund management house that focuses on small caps. I had seen him deliver a webinar and was eager to pick his brains. And guess what, he let me! What I’ve learnt is that if you don’t ask, you don’t get. We got talking about all sorts of things in investing land and he was telling me how small cap research is a really intensive area. Basically not for the light-hearted. Read here the price you must pay to get the rewards from investing.

His company also has one of the largest small cap research teams and their analysts know their sectors like the back of their hand. And this is exactly why it can sometimes really pay off to splash your toes in small cap waters. They’re unchartered but that’s what makes them really exciting, for me anyway!

The perfect antidote for inflation

The really snazzy thing about small caps is that these tend to be businesses that are extremely niche so they’re more able to raise prices (than say, a bog-standard supermarket is) and their consumers will very often keep coming back. Despite price hikes. And it’s exactly this pricing power that makes small caps a great addition to any portfolio as it will give you some sort of inflation protection! (Psst: worried about that? Read here 5 simple and most underrated ways you can start making money now)

Think of it as a handy-dandy handbag umbrella that fits anywhere, perfect for that rainy day.

But when inflation gets outa hand (like now??) then small caps might not perform as well as if inflation were a little less high. But, if these companies have the potential to grow their earnings by five or even ten times over the coming years then wherever inflation travels to, it isn’t really a big deal. And frankly won’t really matter. 

So, while you’ve probably made a ton of room in your portfolio for the Big Guys don’t neglect the Little Guy. 

Small is beautiful. And mighty. 

Disclaimer: This blog is not investment or financial advice. It is my opinion only. This blog is not a personal recommendation to buy/sell any security, or to adopt any such investment strategy. Always do your own research before you commit to any investment.