It’s perhaps fair to say that a lot of attention within the investment community is focused on companies with large market values. That focus is not always logical, but there is a reason behind it. Let’s find out why that’s so, and along the way, discover how we might be able to find hidden treasures in the market.
Why big investors invest only in big stocks
Institutional investors consist of the large mutual funds, insurance companies and state investment companies, like Singappore’s own Temasek Holdings. Institutional investors tend to invest mainly in companies with large market capitalisations. This is because they are typically in control of huge sums of money and investing in companies with small capitalisations can’t move the needle for them.
For instance, let’s consider CNA Group (SGX: 5GC), a company with a market cap of S$55m. Hypothetically, even if Temasek, with more than S$200b in funds, buys up the entire company and makes a 500% return on its investment, the total gain is just 0.1% of its funds.
Therefore, due to size constraints, the investable universe for big institutional investors (like Temasek, for instance) are more or less restricted to large-cap companies like Singtel (SGX: Z74), DBS Group (SGX: D05) and Olam International (SGX: O32), which are worth some S$56b, S$42b, and S$3.6b respectively.
Because of that, small-cap companies can often slip under the radar for most of the investment community.
Myths about Small Cap
However, some might suggest that small caps are riskier than large caps. I believe otherwise – small caps are just misunderstood.
As lesser information is available regarding smaller companies, this leads to a fear of the unknown by the investment community. When fear is combined with unfamiliarity, prejudices are formed.
With more education, we should be able dissolve this fear and alter the way we feel toward these prejudices. This is as true for other areas of life, like racial issues for instance, as it is for investment.
Foolish Bottom Line
Investing is about constantly educating ourselves. It is about learning to evaluate businesses and their management. It is about understanding how the other participants in the market behave, how their actions might affect us and how we should react in return. Most importantly, it is about understanding our prejudices and how we can dissolve them in order to prevent them from harming our returns.
The more we educate ourselves, the more we might realize that many of the lessons learned in the investing area, are applicable to something even greater: Life itself. And that, I believe, is the true hidden gem to be found in the market.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.