This is the time of year the baby fawns start come out.
Photo: Bryan Hanson. Source: Morguefile.
Fawns are adorable. They gambol and play and remind us of the cycle of life. But they’re shaky on their new feet. Like everything that starts fresh, the first few steps can be unsteady.
In this, they’re a lot like small companies. Small stocks are a lot more volatile than big stocks. They can jump or drop by up to 20% in a day and no one notices, but it’s big news if a giant company like Apple or Exxon moves more than 3%. And the small cap indices are more volatile than groups of blue chip stocks, too. Over the past decade, large cap monthly volatility has been around 15%, while small caps average around 20%.
This instability means they’re riskier investments, but it also means their returns can be higher, too. And there’s no free lunch: investors demand a higher return to compensate them small company’s risk. But why are small firms so volatile in the first place?
It’s often asserted that small companies have fewer resources. But with instututional funding and start-up engines like Y-Combinator, this isn’t necessarily so. Some say that inexperienced management is more likely to make business gaffs. But lots of small firms are run by managers who learned their craft in the corporate jungle, but prefer to work in a smaller firm, where they can have more fun.
Photo: Doug Tengdin
It’s more likely that small company volatility comes from something more common: news. News stories that barely affect corporate giants can be a big headache or huge source of encouragement to a smaller enterprise. The big pharmaceutical company Merck was hit with by a ransomware bug and the stock hardly budged. They spend over a billion dollars a year on capital expenditures. A few hundred thousand more on computer security isn’t even an asterisk. But such an requirement could sink a small company
News stories are random: they come from anywhere and everywhere, without rhyme or reason. But it takes a really big story to affect a big company, and those aren’t that common. It’s like sailboats at sea. The big storms hurt everyone, while little squalls only hurt smaller craft. But small boats are more maneuverable and can navigate in waters too shallow for the big ships.
Photo: Christopher Enoksen. Source: US Coast Guard
You can’t plan what news is going to hit next. You can try to be ready. If you’re prepared for the ups and downs and jumps and spills, small cap stocks can be a good source of returns.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”