"If I was running $1 million today, or $10 million for that matter, I’d be fully invested… It’s a huge structural advantage not to have a lot of money… The universe I can’t play in has become more attractive than the universe I can play in. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in."
Warren Buffett, 1999, discussing small-cap stocks
Editor’s note: This week Daily Prophet readers will be receiving conetent from the SmallCapInvestor Daily Newsletter since I am traveling for the holidays. Enjoy!
Warren Buffet has got to be one of the greatest investors of all time, and he certainly provides some great material for the media. I included the words quoted above as an introduction to the first chapter of my book, The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks. They provided a great lead in to a discussion of why small-cap stocks have a place in every investor’s portfolio.
Last week I discussed the out-performance of small-cap stocks over the long-term. Today we’re talking about why small-cap stocks are such strong performers. Some of this content I’ve included in the first chapter of my book, but I want to bring it to you here today in SmallCapInvestor Daily.
Almost all great companies start out small. The exceptions are those that are formed as spin-offs from large companies or joint ventures between two big, existing companies. But even many of these start out small. And many of the world’s greatest innovations come from these small, nimble companies. In fact, it is the little guys that have increasingly been investing in research and development in recent decades – and helping to fuel economic growth in the process.
It is this growth that is the reason small-cap stocks shine since the greatest rate of growth is often during a company’s early days. This is when they are producing new products, launching strategic partnerships, and entering new markets – all while flying under the radar of larger competitors and Wall street analysts and investors. But often these efforts are rewarded once enough investors realize the company’s potential, and if the company continues to perform.
In 1981, 71% of corporate research and development dollars in the U.S. were spent by companies with over 25,000 employees. Companies with fewer then 1,000 employees spent just 4%. But by 2006, the tides had shifted and small companies spent 23.7% of overall dollars while the big boys spent only 38%. The rise in R&D spending is fueling innovation, jobs, and technology development in small companies. And the best go on to become publicly traded small-cap stocks.
Once public, investors like you and me can buy part of the company and help to fuel the company’s growth through our investment while profiting from its breakthroughs. But its not just new companies that are small-caps, often when firms fall on hard times their stock plummets and their market cap falls below $2 billion. This was the case recently when several publicly traded companies were pummeled by the market – just take a look at some of the homebuilders like Toll Brothers (NYSE: TOL). The current $18.40 stock price means it has a market cap of $3 billion, while back in July of 2005 the stock traded three times higher at levels above $55.00. At the March lows this was a true small-cap stock with a share value of only $14.28.
But small-cap companies are often up for grabs, and overlooked by the investment community. That means individual investors doing their homework often will find excellent investments not yet widely recognized by the smart money crowd on Wall Street. As I state in my book, "Small caps are where Main Street Investors like you and me can enjoy extraordinary returns."
Often small-cap stocks are thinly traded, meaning only a small number of shares trade on a daily basis. This means that even moderate buying pressure, or buyer-demand, can drive a stock’s price higher. In fact this exact scenario may be happening with a small cap stock that I have in the SmallCapInvestor PRO portfolio. It shot up 10% in one day after it announced an equity offering. This stock trades only an average of 50,000 shares a day, but demand for the new stock propelled all shares higher. I’m watching this stock closely to see if the daily volume of shares traded continues to increase. To learn more about SmallCapInvestor PRO, sign up for a no-risk trial subscription by clicking here.
This is the scenario the Oracle of Omaha was referring to – investors with lots of money to invest have a hard time getting good entry prices on small-cap stocks since their demand will drive the price higher. But that doesn’t mean big money doesn’t move into small-caps, it does. And you want to be in there first because that new money will mean big percentage gains for your investment.
To give another example, another SmallCapInvestor PRO portfolio stock, China Green Agriculture (NYSE: CGA) has increased 100% since I added it to the portfolio. Just take a look at the recent headlines on this little gem and it’s clear that institutional investors have been buying the stock. One of these was from Investor’s Business Daily on December 4 entitled: Organic Fertilizer Maker Profits as China Worries about Pollution. Two days later that stock was 7.3% higher. I’m watching this one closer as well to see if more analysts start covering the stock – this could really help to move shares higher.
As Buffets words show, even the world’s greatest investors are huge fans of small-cap stocks. The reason is pretty simple, small caps are massive generators of growth and that growth is greatest in the early stages of a company’s development. In SmallCapInvestor Daily, and my SmallCapInvestor PRO advisory, I seek to help you find these high-growth and high-return small cap stocks, so that you can add them to your portfolio for big gains.