When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Investing in big vs small companies
There are some important differences between big and small companies that present both opportunities and risks when investing in their stocks.
Investopedia
“Smaller companies have greater growth potential and tend to offer better returns over the long-term.”
Small caps vs large caps
Source: Calomos.com. Past performance doesn’t guarantee future results.But If the goal of investing is to generate a return, why don’t we all invest in small companies?
By extension, why the most popular investments are index funds, which track indices like the S&P 500, made up of the largest 500 companies in the USA? These funds have billions of dollars invested in them. If the long-term returns are anything to go by, funds with small-cap stocks should be the most popular.
Like all things in investing, things are not as simple as they seem.
By extension, why the most popular investments are index funds, which track indices like the S&P 500, made up of the largest 500 companies in the USA? These funds have billions of dollars invested in them. If the long-term returns are anything to go by, funds with small-cap stocks should be the most popular.
Like all things in investing, things are not as simple as they seem.
Big ideas
- The law of diminishing returns dictates that the growth rate for a business must slow as it gets bigger. The higher potential growth of small businesses makes them appealing.
- Smaller businesses fail at a much greater rate than big businesses, making the risk of investing much higher.
- There are always exceptions. Today’s mega-cap companies continue to grow rapidly, and many smaller businesses are swallowed up by the large ones before they mature.
IBM - When investing in big companies works
Quote
“Who says elephants can’t dance?”
Gerstner was brought in as CEO of IBM in 1993 when the company was losing $16 billion per year, and many suspected it was doomed for bankruptcy. But just 3 years earlier, IBM had its most profitable ever year. This was a business giant struggling to adapt to a rapidly changing computer industry.
IBM's problem was it was just too big. Any decision took too long to pass through the IBM management bureaucracy. Newer, faster, smaller companies were outmanoeuvring it and were able to adapt to the rapidly evolving computer market quicker than IBM, a company that played a significant role in establishing the sector in the first place.
When Les stepped through the front door, the process was well underway to break the business up into parts and call it a day. This giant was destined for the elephant graveyard, but Les had other plans. There was no breakup, and the company has survived to this day.
IBM's problem was it was just too big. Any decision took too long to pass through the IBM management bureaucracy. Newer, faster, smaller companies were outmanoeuvring it and were able to adapt to the rapidly evolving computer market quicker than IBM, a company that played a significant role in establishing the sector in the first place.
When Les stepped through the front door, the process was well underway to break the business up into parts and call it a day. This giant was destined for the elephant graveyard, but Les had other plans. There was no breakup, and the company has survived to this day.
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Is investing in small companies always better?
It's a convincing narrative that small company investments perform better because they can out-move sluggish giants (like IBM).
Apple (AAPL), Alphabet (GOOG), Meta (META) and Uber (UBER) are examples of big multinational companies that were started in the last 10 years. If you had invested early into some of these and held on, your investment would be doing very well.
Apple shares grew by more than 7-fold over the past decade, meaning if a UK investor bought £1000-worth of Apple (AAPL) stock, their holdings would have grown to over £7000. However, such a strong performance from a large company is untypical, and there are many smaller companies, often listed on the Russell 2000 index, that have grown faster than Apple, listed on the Nasdaq. The Trading 212 app includes over 12,000 stocks from the US, UK and overseas, offering the opportunity for commission-free investing across a mix of big and small companies.
Apple (AAPL), Alphabet (GOOG), Meta (META) and Uber (UBER) are examples of big multinational companies that were started in the last 10 years. If you had invested early into some of these and held on, your investment would be doing very well.
Apple shares grew by more than 7-fold over the past decade, meaning if a UK investor bought £1000-worth of Apple (AAPL) stock, their holdings would have grown to over £7000. However, such a strong performance from a large company is untypical, and there are many smaller companies, often listed on the Russell 2000 index, that have grown faster than Apple, listed on the Nasdaq. The Trading 212 app includes over 12,000 stocks from the US, UK and overseas, offering the opportunity for commission-free investing across a mix of big and small companies.
Which big tech investment paid off the most?
Source: StatistaHowever, large companies can and do become small companies or go out of business. Nokia was the world’s largest mobile phone company over a decade ago. Nokia still exists but has closed its mobile phone division.
Companies seem to explode onto the scene as part of a new business trend on a regular basis but are dying at a quicker rate too. In 1958 the average company in the S&P 500 stayed there for 61 years. Today the number is just 18 years.
Companies seem to explode onto the scene as part of a new business trend on a regular basis but are dying at a quicker rate too. In 1958 the average company in the S&P 500 stayed there for 61 years. Today the number is just 18 years.
Average company lifespan on the S&P 500 Index
Source: NPGF.orgBefore you rush into the ‘next big thing’ for every Airbnb and Alphabet that has changed our lives, many more have tried and failed. When investing, you need to be aware of survivorship bias, where we hear much about the successes but very little about the failures.
A study into angel investments (investments into companies right at the beginning of their life) showed those investments resulted in losses between 50-70% of the time.
A study into angel investments (investments into companies right at the beginning of their life) showed those investments resulted in losses between 50-70% of the time.
How to classify a small vs big business
The size of publicly traded companies is classified according to market capitalisation. That is the sum of all their shares multiplied by the share price.
Market capitalisation = No. shares x Share price
This is the general guidance on how to define a big vs small company:
- A Micro-cap business is worth between $50 to $300 million.
- Small cap is worth $300million to $2 billion.
- Mid-cap is worth $2 billion to $10 billion.
- Large-cap is worth $10 - $200billion.
- Mega-cap is anything worth more than $200 billion.
We can group any business into these categories based on market cap. To do that on the Trading 212 app go to the Info & stats section of the company in question, and you can see the market cap under key ratios. The following shows the market cap and other key ratios for Apple (AAPL, Nasdaq), which should be taken into account when considering how to invest in Apple shares from the UK.
Let's say you want to invest in Apple from the UK. You can search using the name of the company or the ticker AAPL in the Trading 212 app. Before you invest in Apple stock, think about whether a large-cap company would add to or detract from your portfolio. You may choose from thousands of trading instruments listed on the London Stock Exchange, NASDAQ, etc.
By categorising companies by market cap, it is possible to test whether the theory of smaller companies being more nimble shows through investing returns. Can these micro businesses out-tango the titans?
By categorising companies by market cap, it is possible to test whether the theory of smaller companies being more nimble shows through investing returns. Can these micro businesses out-tango the titans?
Big business vs small business stocks
There is a school of thought in the investing world known as factor investing. This is simply investing in businesses that exhibit a certain quality or factor on the understanding that, traditionally provides better returns.
One factor you might have heard of is investing based on the ‘value factor’. Warren Buffett is a value investor and very much adheres to this strategy. In fact, there are over 400 different factors.
The factor we are focusing on here is the size factor, i.e. buying smaller high-growth stocks instead of large blue chip stocks. Whether the size factor works is disputed.
The size factor refers to the empirically verified phenomenon that mid and small-cap stocks, with a market capitalisation of between $2 billion and $10 billion, generally outperform large-cap stocks (source: Risk.net).
However, in an article titled "Is the size factor broken? No, it never existed in the first place" Tom Ecket presents evidence to prove the size factor isn't empirically proven.
One factor you might have heard of is investing based on the ‘value factor’. Warren Buffett is a value investor and very much adheres to this strategy. In fact, there are over 400 different factors.
The factor we are focusing on here is the size factor, i.e. buying smaller high-growth stocks instead of large blue chip stocks. Whether the size factor works is disputed.
The size factor refers to the empirically verified phenomenon that mid and small-cap stocks, with a market capitalisation of between $2 billion and $10 billion, generally outperform large-cap stocks (source: Risk.net).
However, in an article titled "Is the size factor broken? No, it never existed in the first place" Tom Ecket presents evidence to prove the size factor isn't empirically proven.
Investing in big companies that are getting bigger
Big businesses are big for a reason. They are good at what they do. The notion that a big business becomes stale and fails to evolve is only true in some cases. The reality is many large businesses continue to grow and evolve.
It makes sense that big businesses continue to grow because they have the manpower and financial resources to do it. They have the budget for research and development (R&D) and can offer attractive incentives to get the best staff. The dominance of the big 5 US tech stocks in modern times is proof that big businesses can get much bigger.
It makes sense that big businesses continue to grow because they have the manpower and financial resources to do it. They have the budget for research and development (R&D) and can offer attractive incentives to get the best staff. The dominance of the big 5 US tech stocks in modern times is proof that big businesses can get much bigger.
Tech companies dominate S&P 500 Index
Source: StatistaThe gap between the median value of a small cap and a large cap stock has widened, and so has the profitability of larger businesses vs small. The 2008 financial crisis and the covid-19 pandemic have exacerbated this trend. The big corporate guns have the most resources to survive downturns. They can also just acquire any smaller businesses showing potential (and potential competition).
Here comes a gentle reminder that If we take the second company on the list and decide to buy Apple stocks from the UK (yes, you can acquire stocks listed on US exchanges with Trading 212), you can also invest in just a fraction of its value.
Here comes a gentle reminder that If we take the second company on the list and decide to buy Apple stocks from the UK (yes, you can acquire stocks listed on US exchanges with Trading 212), you can also invest in just a fraction of its value.
The appeal of investing in small companies
The reason smaller companies remain a popular hunting ground for investors comes down to the opportunity they represent.
The efficient market hypothesis argues that any information that comes to the market is instantly priced in, and for this reason, it is impossible to beat the market. This hypothesis applies to the large public businesses that make up the stock market. There are millions of experts, analysts and budding investors looking at everything these companies do.
Large-cap stocks get so much attention that finding information that others have missed is next to impossible. Small-cap stocks do not get this same level of attention, so it could be argued that there is a greater potential opportunity there for investors who are inclined to research these businesses.
Another approach to include small companies in a UK account for trading is to invest in small-cap ETFs with zero commission. It’s possible to start commission-free investing with as little as £1 using fractional shares and seize opportunities instantly.
The efficient market hypothesis argues that any information that comes to the market is instantly priced in, and for this reason, it is impossible to beat the market. This hypothesis applies to the large public businesses that make up the stock market. There are millions of experts, analysts and budding investors looking at everything these companies do.
Large-cap stocks get so much attention that finding information that others have missed is next to impossible. Small-cap stocks do not get this same level of attention, so it could be argued that there is a greater potential opportunity there for investors who are inclined to research these businesses.
Another approach to include small companies in a UK account for trading is to invest in small-cap ETFs with zero commission. It’s possible to start commission-free investing with as little as £1 using fractional shares and seize opportunities instantly.
Recap
It’s important to consider the size of the companies you are investing in when you assess the opportunities and risks and balance your portfolio.
Ultimately, investors must look to invest in good companies with the potential to increase cash flows in the future, and it technically does not matter what size the company is. Small companies can become big and vice versa.
You can explore commission-free investing in small and big companies, from the UK, USA, and Europe on Trading 212. Moreover, you can invest small in big companies using fractional shares and own expensive stocks with as little as £1.
Ultimately, investors must look to invest in good companies with the potential to increase cash flows in the future, and it technically does not matter what size the company is. Small companies can become big and vice versa.
You can explore commission-free investing in small and big companies, from the UK, USA, and Europe on Trading 212. Moreover, you can invest small in big companies using fractional shares and own expensive stocks with as little as £1.
- Index Funds: A type of investment fund that follows the performance of a specific market index, offering a simple and low-cost way to invest.
- Small-cap stocks: Shares of companies with relatively low market values, typically offering higher growth potential but carrying greater volatility and risk.
- Large-cap stocks: Shares in well-established companies with high market values, often noted for their stability and steadier, though usually slower, growth.
- Market Capitalisation: The total value of a company’s outstanding shares, calculated by multiplying the share price by the number of shares. It helps investors compare the relative size of different companies.
- Blue chip stocks: Shares of top-tier, reputable companies that have a long record of consistent earnings and are considered more financially secure.
