My first job in the investment business was as an institutional broker. Off I went to Tokyo, Hong Kong and Australia with my bag of Midwest small-cap stock ideas.
Many Japanese institutions were hesitant to look at small companies they had never heard of, but Hong Kong and Australian money managers were intrigued.
It seems to me that many otherwise smart global investors overlook small and micro-cap stocks.
Having a basket of international small-cap stocks as part of your portfolio somewhat softens the higher risk that comes with small-cap investing.
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The big attraction is, of course, the chance for much higher returns.
Smaller companies, primarily because of their lack of visibility within the investment community, often experience a “valuation gap” between their stock prices and their underlying fundamentals.
This is the opportunity, and for international companies (and especially emerging markets), this gap can sometimes present tremendous opportunities if you do your homework.
Here are some of the characteristics of small-cap stocks – all of which present opportunities and commensurate risks.
4 Reasons to Invest in Small Caps
Smaller Capitalization and Low Trading Volume
Small caps tend to be more thinly traded, and this presents a huge opportunity for shrewd investors. As the company grows its revenues and earnings over time and the public becomes more aware of its existence and future growth prospects, demand for the stock can jump sharply as demand for a limited amount of outstanding stock increases.
Potential Discovery by Analysts
While there are dozens of analysts covering major stocks, many small-cap stocks are hardly covered at all. When a prominent analyst does pick one up, the results can be surprising.
Flexibility and Growth Potential
Smaller companies can seize new opportunities and change direction quickly, while big companies are like aircraft carriers or cruise ships, “They take a long time to change direction.”
The management of these companies tends to be more entrepreneurial and less bureaucratic. There is less corporate infighting since everyone knows each other on a personal basis. Many smaller companies cannot offer mega salaries, and stock options are a very powerful performance motivator.
The ability to be nimble enables a small company to seize opportunities much faster than its large-cap brothers. This means potential double-digit growth, not plodding 3-4% growth.
Potential Acquisition Candidates
Of course, big companies and their balance sheets do come in handy as partners or, even better, when they swallow a small company at a hefty premium to market value. This means a nice payday for investors as well. Even if an acquisition does not take place, just the thought of it can be a nice level of support for a stock in a promising sector.
How to Capture Small-Cap Investment Opportunities
Cabot Small-Cap Confidential offers many stellar small-cap recommendations.
Another route is to go with an exchange-traded fund, which is a basket of small-cap stocks.
2 International Small-Cap ETFs to Round Out Your Portfolio
The WisdomTree International Small-Cap Dividend (DLS) ETF follows small-cap, dividend-paying stocks in the industrialized world outside the U.S. and Canada. WisdomTree weights the companies in its basket based on annual cash dividends paid. Due to the dividend nature of the index, the fund focuses on value stocks.
Another ETF option for more growth-oriented investors is the SPDR S&P International Small-Cap (GWX) ETF. This ETF has larger weightings towards consumer discretionary and technology sectors as well as more basic material companies.
But my favorite is a micro-cap fund that over the past five years has posted an impressive average annual return of 18.9%. Over the past decade, it has outperformed its benchmark by an annualized (and unheard of!) 6.1 percentage points and beaten its average peer by an annualized 5.6 percentage points over the same 10-year period. I recommended it to my Cabot Explorer subscribers this week so please join today to learn about and tuck this gem into your portfolio.
As you can see, small-cap investing is anything but small.
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