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Caps race: small vs. large caps Comments

Amy Tailor   |   November 29, 2007
Where are my eyeglasses? I cannot see the Dow Jones� growth. Maybe the problem is not in my eyesight? Warren Buffett, the legendary investor once said, �Don't you have to be in small caps to make big money?� He couldn�t have been more correct. Since 2000, there have been a few large caps that have outperformed, but overall large caps as measured by the S&P; 500 lost roughly 2% annually. Small caps, on the contrary, have done much better - the Russell 2000 (that contains 2000 small cap companies) returned 6% annually over the same time period. In fact, investing in small caps is a clever strategy.

Regardless of the fact that many analysts claimed that blue chips, less volatile stocks, would have very strong position in the days of economic decline, they appeared to be wrong. We can go back and analyze the statictics.

Take a close look at this chart. Small and mid cap companies systematically outperform the big guys. If this has been happening for so long, how certain can it be that small caps won�t put us on spot?

There are several facts in favor of small caps. First, investors have been rushing to purchase growing stocks. This leads small caps to a good performance next year.

"The ability of smaller companies to keep growing is greater than large-caps. It's just the law of large numbers," says Lester Rich, a managing director of StoneRidge Investment Partners. Analysts estimate that net income of the Russell 2000 companies in 2007-2008 will rise approximately 51% as opposed to 6% increase for S&P; 500 companies.

It is also expected that long-term investments in Russell 2000 companies will grow 15%, far above when compared with 6% for S&P; 500.

There is, however, a speculation that small caps may downfall. Man proposes but God disposes.

We are talking about the crisis that the United States economy is currently experiencing. Many experts assure that it�s much safer to stay away risky investments and put your money in stable US Treasury bonds. However, if we listen to everything what the Wall Street folks tell you, we may lose everything to the last penny. Such publications as Barron's, the Wall Street Journal and the Washington Post are warning about a possible oil crisis. We are scared to death that we�ll end up being totally dependant on foreign oil. Everyone knows we are at oil bull market. It is not news that the demand for oil is rapidly increasing in the midst of the war on terror and scarce resources. Wall Street makes us believe in it day by day. However, when Wall Street tells you about �new� trends, �real� crisis and �hot� stocks, in reality they are far from being new and hot. Now when the oil stocks have increased in value, it leaves us with no chance to make any good profits off them. The smart investors are those who bought the oil stocks back in 2000 when the price was $10-11 per barrel.

Why do analysts keep persuading us to invest in �blue chips�? They do so because they want to secure themselves. Blue chips are less risky and the chance of decline is very small. The chance of growth is also small, though. I don�t think you would be happy investing your money and then getting back nearly the same amount after a certain time. If your goal is simply to save, you would be better off putting your money in a saving account. Otherwise you have to take some risk if you want money work for you. Pick some cheap stocks and let them earn you some cash. By the way, you may profit even from subprime mortgage crisis. Warren Buffett has also expressed a desire to make money off it. He is planning to purchase shares of the US largest mortgage company Countrywide. Now when it is not experiencing its prime-time, its shares are negligibly small, he is willing to take advantage of the moment and purchase Countrywide at low price.

In conclusion, I should say that diversifying your portfolio with some small cap and blue chip stocks would be a good strategy if you are not too optimistic about putting all your money in small caps. And if the small guys perform well you�ll make some return. And if not, your losses will be neutralized by blue chip stocks.
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