We all invest in stocks for the same reason, to make money. However, investment styles can be as unique as fingerprints. Amazingly, investor surveys show that most of us do have one thing in common…we love small cap stocks.
Typically, the higher potential returns is what draws us to these smaller companies even though they carry higher risk. Research clearly shows that small caps outperform the rest of the market by a wide margin. Most investors would agree its worth bearing that extra risk.
Why do small caps outperform? And why should you consider putting even more of your money into these stocks? Read on for the answers.
Who Doesn’t Want to Beat the Market?
As I said earlier, we are all in the market to make money, so why not be in stocks that outperform the S&P 500 by 20%? Yes, 20%. In a study conducted over the 80 years prior to 2007, small cap stocks beat the index 12% to 10%.
Don’t make the mistake in believing that’s only a 2% advantage. Its 20%, and I’ll prove it. Let’s say that Bill Gates gives each of us $100,000 to invest this year. At the end of the year we keep the profits and return the $100K to Bill with no interest cost (he’s a very generous guy indeed).
So I make 10% on that money, which puts $10,000 in my pocket. Whereas your small cap picks rack up a 12% return, putting $12,000 in your pocket. Is that 2% or 20% better than me?
Now imagine that you kept doing 20% better every year. Through the power of compounded returns that 20% advantage grows and grows over time.
Case closed. Small caps soundly beat larger stocks.
3 Reasons Why Small Caps Outperform
- Higher Growth Rates: Why is a cheetah faster than an elephant? It’s not the spotted fur. It’s about size and agility. Smaller companies can simply move faster than bigger ones to take advantage of business opportunities. This gives them higher growth rates, which begets higher valuations and greater returns for investors.
- Buyout Targets: Some big companies spend a lot of money on research and development to create next generation products and services. Other companies watch smaller competitors develop the new ideas and then buy them up before they get too big. Since most buyouts are done at a significant premium, it provides another key benefit for the ownership of small cap shares.
- Flying Under the Radar…But Not for Long: There are over 10,000 stocks traded in the US alone. Not surprisingly a lot of small caps can go unnoticed by investors for a long time. But once they do take notice, then things get exciting in a hurry.
Consider that Wall Street analysts hate being the first one to cover a stock because they don’t want to be wrong. But once a small company does get coverage, then usually the ball gets rolling. Each additional analyst report that the stock picks up is a super-charged marketing message enticing that firm’s clients to get on board. As the stock starts moving upwards, then even more investors take notice. It’s a virtuous cycle that plays out again and again. Not for every small cap, but certainly for those experiencing the best earnings growth and estimate revisions.
Each one of these reasons individually makes small caps an attractive investment option. Put them together and it’s abundantly clear why they have outperformed by so much over the last 80 years.
Not All Small Caps Are Created Equal
The investment study we noted above says that the average small cap produces a 12% return. Yet there are some that do 2 and 3 times better than that. Most people assume those would be the ones with the highest growth rates. If only it were that simple.
Our research has helped us isolate the small caps most likely to outperform. In fact, over the last 10 years these stocks have produced a +32.7% annual return versus a brutal -2.8% loss for the average S&P 500 stock.
Right now we are inviting investors to join our priority waiting list to get exclusive details on this research study. There is absolutely no obligation to buy anything. We just want to provide you insight on this small cap trading strategy and how the stock picks it produces could help you greatly outperform the market in the years ahead.
Just click here to learn more.
Best,
Bill Wilton
Bill is an expert on the Zacks Rank stock picking system. You may already know him from his growth stock articles on Zacks.com. He will also be the editor of the soon to be launched Zacks Small Cap Trader.
