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How long do you love small caps?

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October 17, 2010 – Comments (21) | RELATED TICKERS: GOOGL , MSFT , VBK

History shows that small caps are a much better investment, as a group, than mid and large caps.  What history does not show is a world controlled by franchises and growing centralized powers.  I love using history as an investment tool for the future.  And the VBK seems like a great ETF.  However, when I think of the future, sometimes I get too alstry-ish.  I always see articles coming out about big companies like goog and msft having insane AI technologies, and things like google earth show the dominance of these big brother like companies.

 

Do you think small caps will always outperform, or do you think with the increase in powerful technology it is large caps that will dominate the world from here on out?

21 Comments – Post Your Own

#1) On October 17, 2010 at 2:14 PM, TMFBabo (100.00) wrote:

The powerful technology aspect has never crossed my mind.  My favorite idea of the past 3 months, TSYS, has a market cap under $300M and it's a market leader in almost all of its technology offerings.  It competes with large names such as Ericsson, HP, and Qualcomm and has a more comprehensive set of offerings in its space.

To me, it only makes sense to look at individual companies.  There are more mispriced stocks among stocks with little or no analyst following, which are only present in the small cap space.  

If you want to talk small caps vs. large caps in general, it depends.  If small caps get ahead of themselves, they're obviously not good bets short-term.  They do not always outperform and there have been multiple decades where large caps beat small caps quite handily.

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#2) On October 17, 2010 at 2:26 PM, ikkyu2 (99.26) wrote:

The best small caps usually outperform because they are usually mispriced, as bullishbabo says.  They can also focus their resources on neglected or open market niches, or invent new ones.  A dollar invested in a corporation that is making this kind of bet can pay off huge.

If a giant-cap corporation finds that same market niche, on the other hand, it may occupy it and dominate it, but doing so may not move the needle in terms of revenue and earnings per share, so the stock price doesn't take the same benefit.

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#3) On October 17, 2010 at 3:48 PM, Valyooo (99.35) wrote:

Babo, don't you think a smallcap with little analyst coverage sometimes will never get its mispricedness fixed? It'll only get fixed if people bid the price up, but how do people bid itup if they don't know about it?

And true about small caps filling a niche making them rocket off, but you don't think in the future there will be smaller niches?

And yep large caps don't win sometimes but over a long period small caps win

Tsys isn't that turkish company right?

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#4) On October 17, 2010 at 3:56 PM, Valyooo (99.35) wrote:

Babo, don't you think a smallcap with little analyst coverage sometimes will never get its mispricedness fixed? It'll only get fixed if people bid the price up, but how do people bid itup if they don't know about it?

And true about small caps filling a niche making them rocket off, but you don't think in the future there will be smaller niches?

And yep large caps don't win sometimes but over a long period small caps win

Tsys...is that the turkish company?

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#5) On October 17, 2010 at 4:03 PM, TMFBabo (100.00) wrote:

And true about small caps filling a niche making them rocket off, but you don't think in the future there will be smaller niches?

I bet people were saying that 10, 20, and 50 years ago.  

Tsys...is that the turkish company?

Nope, Telecommunication Systems.  It's based out of Maryland.

Babo, don't you think a smallcap with little analyst coverage sometimes will never get its mispricedness fixed? It'll only get fixed if people bid the price up, but how do people bid itup if they don't know about it?

I'd say the majority of long-term holders of stocks are from institutions.  These are the university endowments, pension funds of various companies, etc.  It is the vast majority of funds invested.  When there are major inflows of money, fund managers have to put the money somewhere.  I highly doubt that a quality company that is mispriced will stay that way forever.

And yep large caps don't win sometimes but over a long period small caps win

No argument from me.  My largest holding currently is GNK at $584M, which makes it a small cap (a small one, at that).

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#6) On October 17, 2010 at 4:04 PM, TMFBabo (100.00) wrote:

Largest holding as in largest by market cap.

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#7) On October 17, 2010 at 4:50 PM, Valyooo (99.35) wrote:

Oh ok nice. I thought you were all about jnj and pg (I've seen you say it mañy times)

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#8) On October 17, 2010 at 6:27 PM, walt373 (99.79) wrote:

Like bullishbabo said, small caps have underperformed large caps for long periods of time before, so that's why I turn to valuation to try to tilt the odds in my favor. A good example would be comparing stocks vs. bonds at the turn of the century. Stocks outperformed by a wide margin over the long term, but they were much more expensive than bonds at that point in time, so it should not be too surprising that bonds outperformed over the subsequent ten years.

And in my opinion, big caps on average are better values than small caps right now. Large companies have many advantages over small companies such as better resources, lower costs, brands, and scale (aka durable competitive advantage). Because of the nature of these advantages, they can create virtuous cycles that makes doing business much more profitable.

You have a lot of very profitable and advantaged companies like Intel, Walmart, Johnson and Johnson, etc. trading at fairly low multiples, compared to many small-caps trading at the same or higher multiples. So if you can get two groups of companies trading at similar valuations, then you go with the better positioned companies.

While the small companies do have some advantages, such as innovation and nimbleness, I think these are riskier and lower-probability advantages. If you are taking all small caps as a whole, certainly they cannot all produce above-average innovation and growth. The majority of large caps however, can produce above-average profitability.

That said, there are a lot of small caps and as usual, there are many opportunities in individual stocks. But if you are talking about the averages, then I think big cap will outperform. Anyways, just my 2 cents.

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#9) On October 17, 2010 at 6:37 PM, Valyooo (99.35) wrote:

I bet people were saying that 10, 20, and 50 years ago.

Very true.

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#10) On October 17, 2010 at 7:16 PM, TMFBabo (100.00) wrote:

By the way, I will never buy an entire small cap index.  I'll be handpicking value and GARP plays from the value side of the spectrum.  I think many small cap growth plays are trading at such rich valuations that I would never touch them.

I like what walt373 said about large caps and advantages.  PG and JNJ are built with sustainable growth in mind.  I've seen Procter and Gamble acquire brands from other companies and then grow the brand much faster than its former owners did through its stronger distribution, advertising, manufacturing capacity, better R&D, etc.  

I did own PG and JNJ and had PG as my largest holding at one time, but I be in small caps most of the time.  When the market eventually gets so rich that I have no value play left, I'm going to hide out in some combination of the following: dividend aristocrats such as PG/JNJ, utilities, bonds, and cash.

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#11) On October 17, 2010 at 8:23 PM, Robuh (25.33) wrote:

I'm pretty sure that small caps yield better returns on average over long periods of time. The problem is risk (volatility) and the fact that you have to have the stomach for short term swings. Unless you do your homework on small cap equities you own you can be prone to selling at the exact wrong time. 

Buying small cap index funds/ETFs is about the worst idea I can think of. IMHO it's far better to look for deep value where companies are mispriced and let time work to your advantage. The fact that a company has a small market cap doesn't necessarily mean it's young and immature (or that it has growth.) 

I generally ignore market cap for the most part. In my mind it's all about finding the best value for your money. If PG was trading at $45 right now I'd have a lot more of it. As it is, there are just too many bargains in smaller companies right now. I'm awash in East Asian annual reports and MD&As trying to compile a basket of companies I want to own for the next 5+ years. 18 months ago it was a much different story. Just look for value. 

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#12) On October 17, 2010 at 11:21 PM, TMFBabo (100.00) wrote:

but I be in small caps most of the time

LOL.  I change around my sentences a lot, but I guess I never got around to fully changing that portion.

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#13) On October 17, 2010 at 11:39 PM, topsecret10 (< 20) wrote:

  I will put my best 5 small caps against anyones best 5 big caps any time....   With small caps you have to be a good stock picker. There are hundreds of undervalued small caps out there that many people have never even heard of. Do your research,and find the next GOOG before somebody else does....    TS  :)

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#14) On October 17, 2010 at 11:54 PM, Mstinterestinman (< 20) wrote:

My favorite small companies are RMCF,MCF And EBIX I'm pretty partial to dividends but I own I think three companies without one if its well run and I like growth potential I'll still invest without one.

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#15) On October 18, 2010 at 12:36 AM, pennystockguy (85.00) wrote:

Small CAPs perform better if you use a method such as this.

30 small cap stocks

10 of which you like

5 of which you buy

1 blows up on you

3 make decent returns but don't show continuing growth so you dump at a 10-25% gain

1 makes a multi-year run.

My small cap performance has improved significantly since using Motley Fool.  I basically do my initial screen, CAPs eliminates 75% of those stocks, I green thumb the 25% I like and buy one or two of the best. 

There will always be new small cap companies regardless of how big GOOG and other big tech stocks get. 

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#16) On October 18, 2010 at 1:50 AM, Valyooo (99.35) wrote:

Buying small cap index funds/ETFs is about the worst idea I can think of.

Why?  The small cap ETFs have done spectacular since their inception, beating the S&P by 40 percentage points since 04

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#17) On October 18, 2010 at 10:23 AM, Griffin416 (99.98) wrote:

http://moneycentral.msn.com/investor/charts/chartdl.aspx?PT=11&showchartbt=Redraw+chart&compsyms=mdy&CA=1&CB=1&CC=1&D4=1&D5=0&DCS=2&MA0=0&MA1=0&CF=32&D7=&D6=&symbol=IWM&nocookie=1&SZ=0

The Mid caps outperform, the small caps is second best over a longer period. It works even further out, I just can't find a longer chart, but it is longer than yours.

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#18) On October 18, 2010 at 10:50 AM, facwinjeff42 (< 20) wrote:

Fascinating commentary, everyone. This thread taught me a lot. Thank you.

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#19) On October 18, 2010 at 11:37 AM, Valyooo (99.35) wrote:

http://finance.yahoo.com/echarts?s=VBK+Interactive#chart2:symbol=vbk;range=my;compare=mdy;indicator=dividend+volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

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#20) On October 18, 2010 at 3:12 PM, Griffin416 (99.98) wrote:

Yup, MDY has been around much longer though. Hard to tell, but MDY has a dividend more than 1% larger than VBK, so it DOES outperform when you factor that in.

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#21) On October 18, 2010 at 4:53 PM, Valyooo (99.35) wrote:

I think the chart readjusts for dividends

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