IMO, I find this view to have more validity if one is buying companies with market caps of, say, 5-10 billion, than those with caps of over 50 billion. Certainly there are exceptions, but the continuation of rapid growth as the numbers get larger just becomes very difficult. Most of the really significant money in the market lies in buying successful companies before they get big.
Excellent point, Bridge. Here is an oversimplistic little model I ran for myself (aren't they all oversimplistic?).
Say your large cap has a probability of 0.6 of doubling in the "long term" (say, five years or so). Similarly, apply the following probabilities of it going to 4x, 10x, and 100x of .2, .1, and 0. Going the other way, give it a probability of 0.1 of going to 0 (not really zero, but enough so that your losses would be the equivalent of it going to zero, as happened to many in the recent market dive).
Now, for a small or mid-cap with a promising future, let's shift the probabilities towards the upper end, but also recognize that they have a larger chance of going to zero. I've used its probabilities of 0.1, 0.2, 0.4, 0.2, and 0.1 of it going to 0,2,4,10, and 100. The 100 case would be the small cap (say, under $1B) becoming a large cap in the long term.
If you run those probabilities out, you find that your expected gain in the large cap is a respectable 3 (triple your money), but for the small/mid cap it is a life-changing 14. However, the variability (std deviation) for the large cap is 2.6 versus 28.8 for the small/mid cap.
So, this simple model supports your conclusion that on average one will make much more money by investing in small or mid caps, but should be ready to tolerate much wider swings, and there is a chance of losing all of one's money. I believe an example of this lesson was shown over the last two weeks.
As I said, one can change the numbers and run other scenarios, but for most reasonable distributions the chance of that small cap becoming a large cap will be the determining factor, and will not change the overall conclusion.
Based on this, and other lessons learned over the recent past, I have modified my investment philosophy somewhat. For options, I prefer to buy common and slightly OTM leaps for large caps, and large number of cheap way OTM calls on small caps, as far out as possible. I fully realize that most of the time these will expire worthless, but all I need is one horse to come in. It is gambling, no more, no less. But it is gambling with money I can afford to lose. In the meantime, my large caps will keep plowing ahead, but I don't expect to hit the jackpot with them. For that reason I also avoid deep ITM, since I believe it is equivalent to margin buying.
One other thing, in this current market I am mainly in cash until the Fed is done. The two prime directives are, Preserve Your Capital, and Don't Fight the Fed. |
