Why invest in small caps?
Smaller companies, or small caps, present common features across Europe, the US and Japan. Here are the four main similarities:
Small-cap companies are traditionally reckoned to offer the potential for stronger growth than large caps. Being often focused on a narrower set of markets and products, small caps can outperform larger rivals significantly when their business model meets a favourable environment. Furthermore, they tend to be able to react faster than larger companies when it comes to seizing new opportunities. As a result, they can latch on to opportunities before the herd and develop more rapidly.
Small-cap companies are often targets for acquisitions by large caps, particularly when these large companies can easily access liquidity (as is the case now) and do not want to privilege organic growth. This scope for M&A activity can provide small-cap investors with further upside potential. Identifying those small caps whose market valuations could benefit from a premium as potential takeover targets is part of what an active investor seeks to achieve.
The wide range of small-cap stocks available for investment allows an active investor to potentially generate significant outperformance over index investing. Small caps tend not to be covered as intensively by analysts as are large caps. So, an experienced and able investor who through thorough fundamental analysis identifies small-cap stocks in sectors with a favourable environment can reap attractive rewards. Selecting the winners among small-cap stocks can contribute to investment performance more than allocating to specific sectors.
Small caps have a distinct risk/return profile that can add diversification to an equity portfolio.
To view the full infographic click here
To view the video ‘Small is beautiful’ click here