Mention sharemarket investing, and our big companies tend to come to mind. But small companies can have plenty of potential for capital growth.
By “small” I don’t mean the local store. There’s no hard and fast rule of what constitutes a small listed company, but they typically have a market value below $2 billion.
To put that in perspective, the Commonwealth Bank – a goliath of the Australian sharemarket, is valued at $125 billion.
Small companies have had a good run in recent years, with the S&P/ASX Small Ordinaries index reporting total returns (including dividends) of 10.39 per cent over the last three years, and 7.07 per cent over the past five.
By comparison, the ASX 200 index, dedicated to our biggest 200 companies, dished up total returns of 7.69 per cent and 5.83 per cent over the same periods. The appeal of small companies is they can be a source of capital gains.
These companies tend to be more innovative, and can respond more quickly to changing environments or take advantage of niches in the market. There are risks too, though.
A small company may have just one product or service; the business model hasn’t yet been tried and tested; and without substantial reserves to shore up any losses, they can be more vulnerable if a product fails or if their main market tanks.
This is why investors in small companies need to take a long-term perspective.
After all, today’s sharemarket minnows are the companies of the future.
Paul Clitheroe is chairman of InvestSMART, chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.