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Can Large-Cap Shares Actually Become Bargains More Frequently Than Small-Cap Shares?

It’s not uncommon to find investors making the general assumption that large-cap companies (companies with huge market capitalisations) have prices that are highly reflective of their ‘real’ intrinsic value given the amount of coverage they get from the investment community. It is also because of this reason that many investors believe that companies with small market capitalisations are normally more mispriced due to the lack of attention.

However, there is another school of thought; that the size of a company has no relationship with how efficiently it’s priced in the market. For this particular school of thought, large-cap companies might in fact be priced inefficiently due to the complexity involved when trying to value them.

How do you value a complex large-cap company?

To illustrate my point, let’s take the conglomerate Keppel Corp (SGX: BN4) – with its large market capitalisation of S$20.2 billion – as an example. How should we go about valuing this company?

Keppel Corp operates in three main business segments: Offshore & marine; Infrastructure; and Property. It also has numerous investments in other companies and listed-entities as well; these include Keppel Land (SGX: K17), Keppel REIT (SGX: K71U), and Keppel T&T (SGX: K11) just to name a few.

For someone trying to value Keppel Corp, he or she might need to make many different assumptions about each segment, including assumptions about the geographic risks the company has to face for each international project. To add on to that, some of the investments Keppel Corp owns are disclosed with limited information. For investors, such obstacles might create difficulties in valuing the company accurately.

Now, imagine each investor making his or her own wildly-diverse assumptions when valuing the company. Wouldn’t the range of the estimated fair value of Keppel Corp be extremely wide between different investors? This thus creates a possible situation of highly inefficient pricing for the company’s shares. And if a company’s often priced lower than its actual intrinsic value, this can create opportunities for intrepid investors.

A much easier valuation process for smaller companies

If we compare the valuation process for Keppel Corp with that of a smaller company like HanKore Environment Tech Group (SGX: B22) (with its market capitalisation of S$620 million), the difference can be stark.

HanKore’s basically operating in the water treatment industry in China. It is a single-segment-company that’s operating in a single geographical market. The quantum of assumptions an investor needs to make in this case is far fewer and thus, the possible differences between the fair value calculations of different investors for the company might also be much smaller. This can then led to a more efficiently-priced company.

Foolish Summary

To be clear, I am certainly not encouraging everyone to start looking at larger-cap companies and disregard smaller companies as a whole. My aim was to hope to show that good investments can be found regardless of the size of the company and that we should not try to have self-imposed restrictions that limit our search for good investments.  It’s my opinion that this is true for finding great investments in the stock market as it is for finding great opportunities in life in general.

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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.