Does Size Matter in Investing?

I must be getting old.  In fact, having recently turned 40, I have hard proof that I am (in the shape of the cards, socks and pants that I received).  It’s not turning 40 that’s making me feel like an old curmudgeon, though,  it’s my approach to risk.

Having written about the need for sufficient diversification, I’ve been thinking about what a company’s market cap means in terms of how sophisticated an investor should probably be before buying the company’s shares.

I realise this isn’t a new idea, but there is very probably an inverse relationship between the size of the company and the minimum sophistication of the investor.  In other words, the bigger the market cap, the less the investor needs to know about the company and the smaller the market cap, the more they should know.

In some ways, this may be counterintuitive because a company like BP is massively more complex than something like AGA Rangemaster.  That’s not just because BP is bigger, it’s because it does many more things in many more places around the world.  Just compare the annual reports.

But, somewhat like the QE2 luxury liner compared to a speed boat, the QE2 is hugely more complex but also hugely more stable when faced with storms and worse.  When travelling across the Atlantic, most people would be better off on the big boat.

This also ties in with the idea that fundamental investing, of which value investing is a part, is about investing in real companies and not just a wiggly stock price chart or a number on a ticker.  An analogy that I sometimes use is that investing in shares can be like investing in property, where there is a real asset generating a real income and potential capital gain.  From that point of view, it’s much easier to think about where Marks & Spencer might be in 5 or 10 years’ time than a micro-cap company that doesn’t have access to the best brains in the business.

For the ultimate in stability (at least in terms of equities), you just have to look at a market index like the FTSE 100.  Not only is it full of the biggest 100 companies, but it’s cap-weighted, so the biggest of those companies make up a disproportionate amount of the index.  The average market cap is about £15 billion, which is big enough, but the weighted average market cap is over £40 billion, which is bigger than all but 10 of the constituents (i.e. BP makes up about 6% of the index at £90 billion while Hargreaves Lansdown makes up 0.1% at £2 billion so the weighted average is slanted towards the biggest of the big).

I’m not sure I’d call myself a big-cap investor just yet, but for my ‘defensive value’ portfolio, I’ll be concentrating on FTSE 350 companies from now on.  Not that there aren’t many great small-cap companies out there, it’s just that I think it’s much easier to find good, big companies than good, small companies.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

4 thoughts on “Does Size Matter in Investing?”

  1. “In fact, having recently turned 40”

    Time for some nose hair clippers then, methinks. Get a “three-in-one”. I trim my eyebrows on occasion. No kidding.

    Remember, you’re only as old as the woman you feel.

    1. I don’t understand hair. As you get older all the areas of your body that didn’t used to have hair suddenly get it, and the bit where you actually want it starts to lose it all. I have to wear a hat now in winter to stop my poor shiny bonce from freezing.

  2. Hey John,

    In fact, when you are investing in one large cap company you are implicitly diversifying, as that company may probably have different business units in different geographical areas, which diversifyes the risk.

    In my investment style, I usually use concentrated portfolios, with a few names, that I study thoroughly and financially healthy, i.e. very low debt ratios and enough earning power to pay future debt instalments.

    Anyway, beware with your hair. At least this winter have not being too cold…

    Nice to write to you,


    1. Hi Manuel, good to hear from you. Your right on the money about implicit diversification which is why I often like international businesses that have their fingers in pies all over the world. I won’t mention my hair in case it becomes the main topic of this comment thread.

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