A big advantage that individual investors have over Hedge Funds and Mutual Funds is that large funds cannot buy small-cap stocks at least it wouldn’t make sense for them to. The average Hedge Fund has $26 billion under management. A small-cap stock is one with a market cap between $300 million – $2 billion. If a Hedge Fund wanted to buy a stake in a small cap stock, it’d be such a small part of their portfolio that the stocks return wouldn’t really matter. This is why these funds mostly don’t buy stocks of this size.
That is one of the reasons small cap stocks are such an advantage to the average investor. They get to buy into these companies before all the institutional money even can. If one buys a small cap stock and the stock keeps growing, it will eventually be big enough where institutional investors can deploy enough capital into the business for its returns to matter, but it can be very beneficial to buy into these companies first.
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Also, small-cap stocks have more opportunity. It is much easier for a stock trading at $2 billion dollars to become a company worth $200 billion than it is for a company worth $200 billion to become worth $2 trillion. Investors looking to 10x their investment have a much better chance in small-cap stocks than large-cap stocks.
Now, this isn’t to say that small-cap stocks don’t have disadvantages as well. First, they are far more volatile. They also have a much better chance of going bankrupt than a large-cap stock.
Not all small-cap stocks are created equal either. We look for small-cap stocks that are growing year-over-year while trading at a reasonable premium relative to its earnings. There are other important factors to look at as well when buying a stock, but we look for stocks that are growing both revenue and earnings year-over-year.
I don’t believe that anyone should only invest in small-cap stocks, but it can be very beneficial to include them in a portfolio.
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