“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50 percent a year on $1 million. No, I know I could. I guarantee that.
The universe I can’t play in has become more attractive than the universe I can play in. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in.”
— Warren Buffett, discussing the advantages of small-cap stocks
Small-Caps Vastly Outperform Large-Cap Stocks (historically)
All great companies start out small. They are built by entrepreneurs who invest their time and money, raise capital privately, and turn their dreams into reality. Many of the world’s greatest innovations come from small, entrepreneurial companies and very few come from the behemoths. Even the Microsoft’s, Wal-Mart’s, and Cisco’s of the world were all once small caps and if you can by these stocks early, before the broader financial arena and when they are profitable and trade at low prices with great growth prospects, your returns can be explosive – long term.
Again, many of the biggest and most successful companies in the stock market started out as small caps – so unless you’re invested in this group of stocks, you’re literally missing out on the best potential gains. The problem is that most investors look at small-cap stocks all wrong. Not all small caps provide value or a good risk to reward profile. Inexperienced investors either chase stocks that are overpriced, hold losers far too long hoping for a turnaround, or they just never even hear about long-term potential winners because these stocks are not yet household names.
Fortunately, KeyStone is here to help you navigate this market – and introduce you to some of the best, profitable small-cap value and growth stocks on the market.
But first off, what are small-cap stocks? Essentially, they are stocks with a relatively “small market capitalization.” The definition of small cap can vary, but in our Canadian Coverage Universe (we also cover U.S. small-cap stock selectively when the opportunities present themselves), we classify our market capitalizations as follows:
Micro-Cap Stocks Covered (Small Percentage of Coverage): Market Cap of less than $35 million.
Small-Cap Stocks Covered (High Percentage of Coverage): Market Cap of between $35 million – $150 million.
Mid-Cap Stocks Covered (High Percentage of Coverage): Market Cap of greater than $150 million, typically to a limit of $2 billion.
Do Not Confuse Quality Small-Cap Stocks with Penny Stocks
The quality small-cap growth and value stocks that we cover should by no means be compared to the world of “penny stock” investing. The companies we cover are typically earnings positive, with strong revenue growth, strong balance sheets, and low fundamental valuations. While they can trade below a $1.00 (many trade from a $1.00 – $50.00 – the market valuation is based on market-cap, not share price), the stocks we cover are not fly-by-night organizations with an “idea or concept,” a moose pasture in Saskatchewan that “promises” to be the next great diamond mine, or a money loosing enterprise. In fact, we specifically avoid these types of “penny stocks” in favour of strong, high growth businesses that have the potential to provide shareholders with tremendous long-term returns.
1) Small-Cap Stocks Historically Outperform Large-Cap Stocks
Between 1926 and 2004, large-cap stocks had an average annual return of about 9.26%. Accordingly, $10,000 invested in large-cap stocks in 1926 would have grown to about $10 million by 2004. That’s not too shabby. However, it pales in comparison to the astonishing 15.9% annual return of small-cap stocks over the same time period. $10,000 invested in small-cap stocks in 1926 would have grown to about $1 billion by 2004! There is also a famous Ibbotson study, which examined the U.S. markets over 70 years and found that small-cap stocks outperformed large-cap stocks 79% of the time over a 15 year period and 95% of the time over a 20 year period.
2) Buy Before Big Institutions Can Buy
Just like the Buffett quote above states, you have an advantage buying at the small-cap level. It is one of the biggest advantages of investing in small-cap stocks and gives you the opportunity to beat institutional investors. Because mutual funds and other investment vehicles have restrictions that limit them from buying large portions of any one issuer’s outstanding shares, many funds will not be able to give the small cap a meaningful position in the fund. As small-cap investors, we can buy in early and benefit from institutional buying down the road as the company grows and larger investors are able to buy in – often providing better liquidity and pushing the valuations higher.
3) Lack of Coverage Creates Potential Small-Cap Bargains
In many cases, when Keystone discovers a small-cap stock, we are initially the only official research coverage on the stock and almost always the only independent analysts covering the stock. Compare this to many large-cap stocks which have hundreds of analysts analyzing and following their every move. You can immediately see why the potential to find an undervalued and undiscovered gem is far more likely in the small-cap segment of the market. This is one of the primary reasons why we apply our fundamental research to this area of the market, where we can truly add value and find the best growth and value stocks for your portfolio.
4) Small-Cap Have Higher Growth Prospects
Due to their size alone, small caps typically have higher growth rates than larger companies. At a basic level, it is easier to double earnings of $1 million to $2 million then to double earnings of $1 billion to $2 billion. However, the market often under prices small caps relative to similar larger companies. That means investors are typically getting better value for their investment dollar with the type of small-cap companies we recommend through our research service due to their growth potential, often not fully recognized by the market because of lack of analyst coverage.
Want Individual Proof?
The best test of our service is the test of time. Feel free to check out our annual returns on our “track record” page, which are calculated based on an equally weighted average of all recommended companies throughout that year, if one were to buy an equal amount in each company recommended and held to the SELL price or closing price on the specified dates. The average includes all winners and losers, so it is a strong representation of the gains within that year.
We also suggest you take a look at a few quick “case studies” based on actual BUY recommendations from our research over the past decade to give you an idea of the type of potential gains our small-cap recommendations can achieve when we truly find a winner.
KeyStone Success Stories
Small-Cap Volatility Creates Opportunities
To be perfectly clear, small-cap stocks are intrinsically more volatile, you also need to exercise extra care in examining their fundamentals. Small caps higher relative volatility stems from their relatively low liquidity. This means there are fewer shares available to buy or sell on the open market compared to larger companies, so small caps can move fast, even on relatively small pieces of information or news. For the savvy and well-researched investor, this can mean quick or long-term (as is most often the case) sizable gains. For those who fail to do adequate legwork, steep losses can just as easily be the result.
The financial crisis of 2008 presented generational buying opportunities and our 15 BUY (5 months following) recommendations in the wake of this crisis have made many of our clients excellent returns. Corrections and other mini-crisis’ will continue to provide excellent opportunities for the savvy investor. The key is to have an experienced navigator constantly evaluating and identifying long-term opportunities in all market conditions with the singular goal of providing you with strong, long-term growth for your portfolio.
Investing in a selective group of individual stocks poised for rapid growth and trading at attractive valuations can deliver big gains and improve the total return for your overall investment portfolio. This is precisely what KeyStone’s Small-Cap Research Service is designed to do for you!
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffett