Small caps tend to outperform the market. Why? The market is way less efficient in this space. Let me teach you three reasons why small caps are so interesting, writes Pieter Slegers, editor of Compounding Quality.
First, you are going where competition is weak. Warren Buffett said that size hurts performance. You also see this in the numbers of some of the best investors in the world. They massively outperform the market at the beginning of their careers. But their outperformance starts to decrease once they start to manage more money.
The reason for this? The market is way less efficient in the small-cap space. “To outperform the market, go where competition is weak,” Buffett said. As you can see, Berkshire Hathaway Inc.’s (BRK.A) outperformance decreased as the firm became larger and larger:
Second, you can let your winners run. The most important thing for you to do as an investor is to cut your losses and stick with your winners. Just imagine you had owned Monster Beverage Corp. (MNST) since 2001. A $1,000 position would have turned into over $1 million.
Third, small caps outperform the market. Between 1926 and today, the smallest 10% of companies outperformed large caps by 4.4% per year on average.
Imagine putting $1,000 to work in 1926. By today, you’d have $8.7 million if you invested in large caps…but $430 million if you invested in small caps. The small caps made you almost 50x (!) as much money.
Please note that this example is over a period of 99 years. That’s the magic of compounding put to work.
