The Search for Security
Where can investors find safety?
Photo: Josh Rogan. Source: Morguefile
The answer to this question is far from obvious. In the past fifteen years we’ve seen spectacular failures among both large and small companies: Lehman, Fannie Mae, Quicksilver. And even more companies have fallen dramatically in price and never recovered, like Citigroup or AIG. Now the entire energy sector may be downgraded. When the giants fail, where do you go for safe, blue-chip growth?
The short answer is, there’s no such thing as safety. There were some spectacular failures 20 or 30 years ago, but our selective memories erase them—and the subsequent recovery—because, well, we just forget. Also, our minds tend to recall facts that have strong emotional associations. A tree falling in the forest a mile away isn’t as loud to us as a limb from the maple out front crashing down on our car in the driveway. And a growing tree doesn’t make any sound at all.
Stout Memorial Grove. Source: Wikipedia
Are small companies the answer? Small firms have less experienced managers and more volatile business conditions. They tend to be regionally focused, so local economies affect them more. Since they slip under the radar screens of many auditors, accounting fraud and malfeasance are more likely. As a result, business failures among small firms are much more common. They also grow at a faster rate, though, since expansion isn’t limited by the size of the economy. It’s easier for revenue to double from $5 million to $10 million than from $500 billion to $1 trillion.
So small stocks are more volatile. Investors who buy them need to pay close attention to their balance sheets, business plans, and manager integrity. But there are no sure things in investing. It’s all a matter of managing risk while you look for returns.
Douglas R. Tengdin, CFA
Chief Investment Officer