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The Worst Investing Misconception That I Have Ever Heard

I once had a conversation about investing with someone whom I just met for the first time. He was telling me to invest in many Malaysia small-cap companies. The reason was that all these small companies would benefit when a mega global e-commerce company enters Malaysia. I looked very confused and asked him a question which might have offended him. If he feels that the global e-commerce company is so powerful, why not just invest in the global e-commerce company’s stock?

I think he kind of rolled his eyes on me but he replied with a hint of contempt that he invested in these small-caps because they are smaller in size, which means they have a longer runway to grow in the future.

Being the polite person that I always am, I chose not to argue with a complete stranger and merely smiled and agreed with him. (Maybe I did roll my eyes back at him as well).

But his comment got me thinking. Is it really true that just because a company is smaller, it would have a larger potential than a large company? After thinking for about 10 seconds, I concluded that his opinion is not only wrong, it is one of the worst investing misconceptions to have. Here’s why.

There Is A Reason Why Small Companies Are Small

By his logic of merely investing in smaller companies, then won’t the best investment lie in investing in all the startups with no revenue, no team, no operations and still living in some wannabe entrepreneur’s mind?

Yet according to a Forbes article, 90% of startups will fail. Similarly, most small businesses will just remind small forever. It is illogical to assume that many small businesses will become multi-billion companies in the future just because they started from a smaller base.

Big Companies Are Proven Winners

It is true that all companies start small. Many of the multinational companies in the world now started out as just a single store or a company with just a handful of employees. Yet, there are just a couple of large and successful companies in the world now. These companies are the trial and tested winners of the corporate world.

Instead of investing in the proven winners, why would investing in the perpetual benchwarmers a better strategy? My Foolish colleague, Chong Ser Jing, once made a very compelling article that great returns can still come from large companies.

Foolish Summary

I am not saying that all small cap companies are bad investments. However, we have to understand that looking for great companies within the small cap space is akin to finding a needle in a haystack. Sure, you can find a needle after a long time, but there is still a very big possibility that you are just holding on to a straw of hay.

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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.