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I believe it’s a common misconception that in order to make money
investing in small-cap stocks one needs to “swing for the fences.”
Given their tendency to rise (and fall) further and faster than
large caps, small-cap stocks are often, and mistakenly I believe, viewed
as speculative investments only appropriate for those with a high risk
tolerance.
And that view helps enforce the all-or-nothing moniker that
overshadows the more successful strategy of shooting for consistent,
healthy gains with moderate-risk small caps.
A better strategy (and this goes for investing in any asset class)
is to simply swing to get on base; i.e., buy a stock that has a high
likelihood of rising from the point at which you purchased it.
Since stocks don’t usually go straight up you need to start with at
least a small gain. These tend to grow to moderate gains and occasionally
to the multi-baggers that we all dream of. But they all started as small
gainers in the beginning.
Do this often and I believe you’ll have better average returns than
if you swing for the fences with every small-cap investment.
And right now, as the fiscal cliff looms, small-cap stocks are
being held back from their traditional long-term outperformance. As I
discussed
last week, a resolution to the fiscal cliff that
doesn’t curb growth has the potential to ignite a small-cap rally –
meaning even low-risk small caps should post outsized gains.
Data from PNC Capital Advisors shows that around 80% of company
sales in the small-cap asset class come from North America. Since this is
the region most affected by the fiscal cliff debate, once that issue is
out of the way small caps will have a major burden removed.
Remember, small-cap stocks are much like stocks of larger market
capitalizations, rising and falling along with the market and on
company-specific events. There are volatile ones, and there are placid
ones.
When I try to explain this and get blank stares from my colleagues
(it happens more often than I’d like), I just point to recent examples of
large cap-crowd favorites that have dealt serious blows to shareholders
who bought at the top.
For instance, in the three months after September 19, Apple
(NASDAQ: AAPL) fell as much as 27%.
Between October 5 and November15, Google (NASDAQ:
GOOG) fell by 16%.
And beginning in July 2011, Netflix (NASDAQ: NFLX)
fell more than 75% in just four months.
All three of these companies were large-cap (Netflix is now a
mid-cap) household names – and relatively stable businesses. Buy them at
the right time and they are great investments.
But at the wrong time