Small Caps: Shrewd Investment or Risky Gamble?

Small Caps: Shrewd Investment or Risky Gamble?Some say, “Buy mostly large caps. They are safe for regular folks. Mid caps and small caps are risky. So treat them like garnish, to be sprinkled on top if you feel like.”

Some others say, “Buy mostly mid caps and small caps. They’ll give you huge returns.”

Oversimplified (misguided?) advice.

Just because a company is large doesn’t make its stock safe. And just because it is small, doesn’t make it risky (nor does it make it a goldmine).

When you buy a giant like L&T without knowing what its divisions really do, it’s a risky stock. When you buy a large cap like NTPC without checking your ability to understand upcoming power projects, coal linkages and state electricity boards, it’s a risky stock. And especially, when you don’t buy it for a bargain price, a large cap is a risky stock.

Equally, just because a biotech business or cable distributor or transformer manufacturer is a small company, doesn’t make its stock a stairway to untold riches.

Ask, “What does the company actually do?” Is its position strong? Ask, “Does it provide you sufficient information?” Is the stock price attractive?

The size of a company doesn’t make its stock safer or riskier. No, what matters is its nature, your ability to grasp it and the buy price.

(Disclosure: I do not hold a position in L&T or NTPC at the time of writing this post. Please also read the terms of use.)

4 thoughts on “Small Caps: Shrewd Investment or Risky Gamble?”

  1. Indeed, words of wisdom. But, the investors need thorough education about the process of selection. That is where most of the investors are pushed away. In fact, if there is a full-time univ course then it would be worth the effort.

    1. There are papers on investing at the post graduate level. Most MBA courses offer an elective called Securities Analysis and Portfolio Management. Many ‘certification’ courses also deal with the subject.

      However, I doubt if they serve the need of common investors. You’ll be surprised by how little resemblance what is taught has with investing, as we know it. Blame it on the dominance of maths and physics graduates over academic finance in the past several decades.

      Sad, because the founding father of sensible investing – Benjamin Graham – was a part academic. In fact, Warren Buffett first met him in his Security Analysis class at Columbia University.

      When he returned to his home town, Buffett also taught at the the local university for fun. He continues to interact with students till this day.

      So, unfortunately, (barring some notable exceptions) university education doesn’t really help common investors.

  2. Small, Mid or Large Cap, if the fundamentals warrant then its a green signal. But, the question is at what price.

    Keeping in mind the general weakness in the markets and a bleak future. I have decided on the following.

    Once a list of companies is made, I intend to follow two filters.

    Filter #1 Nifty must reach, atleast 52W low, to even consider any purchase. Only after that will I consider any valuations.

    Filter #2 Will check out DCF, Annual Reports etc only after price of the Company on my list is trading near or below its 2008 low.

    (Except for Metals, where I will want to see some serious consolidations and multiple bottom formations below or at 2008 lows. )

    Isn’t buying at a good price the most important part of value investing?

    I admit, a few companies like TCS, Asian Paints, Hawkins, VST, HDFC, Gruh and several more are possible candidates which I may miss out on. But, the fact is I want only 15 companies from diversified sectors.

    1. Amit, buy price is indeed of great importance to value investors. It gives rise to margin of safety. However, we must be careful of not using it as a cover to hide our fear.

      We must learn as much as possible about the stocks we cover. And yes, price is a vital (although not the only) element.

      So check, recheck, re-recheck the facts. Then step back and think. If you still like the stock, stick to your conviction. Don’t get spooked just because the share prices are falling.

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