Every large company used to be a small or medium size one. Investing in small and mid capitalisation equities has always been considered to be risky because of the “unknown” factors when compared to large capitalisation investments. Large cap companies refer to some of the largest, most well-known companies in the country, and small-cap and mid-cap companies often represent little known firms with revenues between THB 2 billion to THB 10 billion. There is an obvious risk-return paradigm between small, mid and large cap companies, generally small companies exhibit more volatility and are less liquid when compared to large cap companies yet have tremendous growth potential. Mid cap are a moderate alternative between large-caps that may find it difficult to increase shareholder value and the riskier small-caps.
Over the past few years we have enjoyed the intellectual challenge that comes with investing in small and mid caps as well as the returns that come along with it. Extensive analysis in small and mid caps in the Thai Equity market has proven that in each year since the year 2000, Small and Mid Cap companies consistently outperform the broad market and large cap companies.
We applied Morningstar’s definition of what a small, mid, and large cap company is in terms of market capitalisation and performed two analytical exercises, both involve constructing an index, the first is to calculate which companies are small and mid cap the year 2000 and chart their performance by market capitalisation through to 2009 (see graph 1), and secondly the to calculate on an annual recurring basis which companies are small and mid caps and chart the annual performance cumulatively (see graph 2).
Further analysis proved that each year, even during the financial markets debacle in 2008, there would be small and mid cap companies that exhibit growth in market capitalisation allowing them to become mid or large cap companies.
So the final question remains how does one find an attractive small and mid cap company to invest in? Rigorous and in-depth understanding of the company is required when investing in small and mid caps. We feel that one has to look at the investment from both a company and stock point of view. Firstly as a company, it should be a business that you clearly understand, that it provides a service that will be required for a long time, that it has quality management, financial discipline, and hopefully the business is asset-light and scalable. Secondly from a stock point of view, understand how many analysts are covering the stock today and know at what market capitalisation level would institutional investors and first tier investment banks start to cover the company and how long it would take for the company to reach that level.
This is just a morsel of the ideas and analysis we take into account when investing in small and mid cap companies on the Thai Equity Market and despite the notion that investments in small and mid caps are “risky”, when you truly understand the business and its potential, in our mind, this negates the “risky” component of investing in small and mid caps.