I went looking for a pomelo the other day. As it turned out, there was a choice of two varieties available at my local supermarket – there were small ones from Taiwan and ginormous ones from mainland China.
So, which one should I have bought – the small one or the big one?
As far as I was concerned, I just wanted a fruit that was sweet and succulent. Ideally, it shouldn’t be too expensive. Size was somewhat irrelevant. After all, I just want a good pomelo to embellish my salad.
From pomelos to portfolios
Something similar happens when we are choosing stocks to put into our portfolios. We just want to find good stocks that could reward us for the long term. Size shouldn’t really be a consideration. But somehow it can be.
Trouble is, the argument as to whether large caps are better than small caps will probably never be resolved.
Small-cap investors claim that they are looking for the next DBS Group Holdings Ltd (SGX: D05) or the next Comfortdelgro Corporation Ltd (SGX: C52). Large-cap fans, on the other hand, highlight the futility of looking for the next titan, when we can already invest in giants today.
It’s not about size
In my view, size is a red herring. Large caps, or companies with sizeable market values, can have their advantages just as smaller outfits can have their pluses. There are also disadvantages with both.
For instance, many investors like big companies because they are perceived to be less risky.
But those who, say, invested in Noble Group Holdings will probably have a different tale to tell. Risk doesn’t vanish just because a company is worth a lot.
What investors need to remember is that all companies can fall from grace. What’s more, the value of every share can effectively go to zero.
The price of predictability
However, large companies are, in general, less prone to spectacular fails.
Their more reliable revenue streams, coupled with a normally better and broader customer base, make forecasting more predictable ….
…. Unfortunately, the price for that greater dependability is considerably more expensive shares. Consequently, many investors often complain that there are few, if any, bargains in the main indices,
Stability versus growth
But there is a reason why these companies are more valuable. Many large caps have commanding positions in their respective markets.
In some cases, they may even be near monopolies. An effect of their dominant positions could be greater pricing power, which could mean higher margins and stronger bottom-line profits.
However, the flip side of this can be significantly slower growth.
Moving the needle
So, companies whose products and services can be found just about everywhere could find it hard to expand further. And even if they could, any improvement could be marginal. It might not move the needle sufficiently to make a difference.
Small caps, on the other hand, could have a lot more room to grow. And that expansion could be achieved organically, too.
That leads nicely onto cleaner accounts. Investors generally prefer businesses that are easily to understand.
However, big companies have a habit of complicating their businesses with mergers, acquisitions and strategic disposals. It can be an easy way to grow both the top and bottom lines quickly, especially when they can access capital easily.
But acquisitions and disposals can result in more complex accounts that can even leave seasoned number-crunchers flummoxed.
Things that matter
There is another issue. The shares of large-cap companies are generally more liquid, which means that it can be easier to buy and sell their shares. It can be harder to buy shares in some smaller companies, especially those that are founder-led.
But if you are planning to hold onto the shares for the very long term, then liquidity should not matter.
The pomelo puzzle resolved
Whether you like big caps or small caps there is no substitute for proper research and a good understanding of the workings of the business.
There is nothing intrinsically risky about small caps, while large caps can be just as vulnerable to the whims of the market. But if we stay half-alert, then we could pick spectacular performers regardless of their market value.
So, which pomelo did I eventually buy? One of each, of course. And they were both equally tasty.
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None of the information in this article can be constituted as financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Disclosure: David Kuo owns shares of DBS Group.