Investing in Small Caps

Guide: Advanced Trading

Small can be beautiful

If, in 1955, you had invested your savings in a tracker fund that covered the whole of the equity market, each £1 you put in would be worth in excess of £486 (to April 2004).

However, if you had restricted your investment to a tracker fund that bought only minnows, the smallest 2 per cent of companies measured by market capitalisation, each £1 would today be worth £8,123.

It would seem to be a no-brainer then to restrict your investments to the tiddlers that swim around on the bottom of the pond. But, as with all decisions based on such statistics, that would be a dangerously wrong conclusion. Because there is no doubt that if you cast your bait into such murky waters, while there will certainly be a few fine catches, they will be eclipsed by the huge number of tiny fish who, despite their best efforts, are not strong enough to make it to the surface.

By all means do your researches in order to identify possible winners. But a good idea and an attractive prospectus are not enough. Make sure you dig deep and examine such areas as:

  • The management. Are the people at the top of the company tree the right people to be running the business? There's a world of difference between the entrepreneur who is adept at starting a business from scratch and the person who can successfully develop a publicly quoted company.
  • Are there weaknesses in the staffing structure? All too often new companies have not fully developed all their strengths, probably in such vital sections as research, quality control, sales strategy or marketing.
  • The competition. Unless it has a unique product - and such a phenomenon is almost unheard of nowadays - a new business will have to fight for an increasing share of its market. Is the appeal of your company strong enough to break up long-term relationships between its competitors and their customers?

These and many other challenges face new companies. Some will survive and thrive. Many will wither and die.

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