Why Shares with Small Market Capitalisations Can Carry Huge Advantages for Investors

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In Singapore, small cap shares (shares with small market capitalisations) are usually shunned by conservative investors due to the belief that they are highly volatile.

However, there is always another side to the coin. Although small caps might see their prices fluctuate by a greater degree over the short-run, they have also been known to earn higher returns compared to shares with larger market caps.

Let’s take a look at 3 advantages that small cap shares have over the rest of the share market:

1. A tangible business

Based on my opinion (and I could be wrong!), companies with small market caps tend to be locally-domiciled and serve a specific niche market. And since such companies are often based in Singapore, investors can do some on-the-ground research to get a much better feel for the demand for their products and services.

One example can be Old Chang Kee (SGX: 5ML), which runs its namesake food retail outlets selling curry-puffs and other fried snacks. As the company’s stalls are often located in heartland malls or in the heart of residential neighbourhoods, it can be easy to get a feel of how well the company’s business is doing simply by observing the number of customers that frequent the stalls.

The company has generated some great returns since it was listed in January 2008. At its current price of S$0.925, Old Chang Kee’s shares have gained 363% since its close at S$0.20 in its first day of trading as a publicly-listed company, By way of comparison, the Straits Times Index (SGX: ^STI) has increased by just 7.7% to 3,294 points in the same span of time.

2. Hidden potential

A small business deal of say S$5 million may be minor for a large firm but it can be a life changer for the small company.

This is can be an advantage for companies with small market caps, especially for those which excel at their jobs. Such companies can receive even more offers and projects over time and even though those deals may be smal, they can still help generate great growth for small caps.

3. Unloved

From time to time, small listed shares with solid fundamentals and cheap valuations can be overlooked due to a simple reason – a lack of coverage amongst investors. When you compare a small company like Japanese restaurant operator Sakae Holdings (SGX: 5DO) (which has a market capitalisation of just S$77 million) with a huge multi-billion dollar firm like real estate juggernaut Capitaland (SGX: C31), it is rather obvious as to which share gets a greater deal of attention.

But, this is also the exact reason why small caps can outperform larger companies over time. The lack of visibility in small caps amongst the investment community can present vigilant investors with the opportunity to take advantage of any temporary “blindness” and buy small cap shares at undervalued prices.

Foolish Bottom-Line

There’s a popular saying that goes like this: Before you learn to fly, you must learn to crawl. Personally, I believe the same goes for companies too – A blue chip today must have had started from somewhere as a small enterprise and grew over time to become what it is now.

Thus, the key lies with identifying the wheat from the chaff amongst all the small caps. I want to find the ones with big visions and executional ability as they are the ones with the highest potential to grow into huge corporations one day.

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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 James Yeo doesn’t own shares in any companies mentioned.