“All great companies started as small companies.” – Ian Cassel
There are several benefits to investing in smaller companies in favour of large-cap stocks. Below we outline three reasons why you should invest in small-cap stocks.
1. Less coverage
Most small-cap stocks have little or no broker coverage in comparison to larger-cap stocks. Therefore, companies with a small market capitalisation tend to fly under the radar of most investors. This lack of attention leads to lower coverage, which ultimately lends itself to having greater pricing inefficiencies in the universe. Thus, unlike larger-cap stocks, investors can have an informational advantage over their peers.
2. Growth prospects
Often smaller companies are in the earlier stages of their growth trajectory, commanding a relatively small market share in their respective industry. These companies are often starting from a low base and aiming to grow market share which, depending on their level of success, can lead to significant value creation for long-term shareholders. In comparison, large caps are often already market leaders in their fields and are more likely seeking to defend, rather than grow their share of the industry pie. It is easier to double the sales of a $10 million company than it is of a $10 billion company.
3. More aligned incentives between management & shareholders
Smaller companies are often run by their founders or a small group of managers who have significant skin in the game. Managers with aligned interests are likely to be highly motivated to deliver strong results for shareholders because their capital is at stake. Put simply, if shareholders win, they win too, and vice versa. It is rare to find larger companies that are founder-led or managers who own a substantial portion of the business.