Thinking Small Pays Off

I can’t tell you how many times I have heard investors talk about the merits of large-cap stocks. For instance, some believe large-cap stocks tend to be more immune to market shocks. Sounds good, but this is not really true. Just go and ask anyone who owns eBay Inc. (NASDAQ/EBAY), Inc. (NASDAQ/AMZN), or General Motors Corp. (NYSE/GM).

 I always hear about large-cap stocks being called “widow stocks.” You buy them and hold them until you retire. Along the way, you should not worry about the ups and downs, or so the theory goes. Again, this may be largely valid and could earn you 7% to 8% annually, but I think you can do much better than this.

 Now, I’m not saying large-cap stocks have no place in your portfolio. They do. But, to attain higher portfolio returns, you should add some small-cap stocks to try to boost the overall return.

 Since the end of the bear market in 2002, the small-cap Russell 2000 Index has easily outperformed both the blue-chip Dow Jones Industrial Average and the broader S&P 500. And at the midpoint this year, the trend has continued, as the Russell 2000 is outperforming the larger-cap indices. The small-cap barometer is down a mere 1% this year, versus 5.07% and 4.99% for the NASDAQ and DOW, respectively. The S&P 500 is down 1.71%.

 The Russell 2000, in fact, has been the only index to hold above its key technical support level. The other three major indices have all retrenched below key technical support levels after failing to hold at key resistance levels (Dow–10,600, NASDAQ–2,100, S&P 500–1,200).

 So will this trend continue? The fact is that the Russell 2000 continues to attract buying from active speculators and traders. These stocks have less Wall Street coverage than their mid- and large-cap counterparts. Wall Street is not that in tune to small- cap stocks, as there are fewer investment banking opportunities in this arena, so there is less of an incentive to cover these stocks.

 But as an investor, you should not always follow the teachings of Wall Street. More often than not, they are simply corporate cheerleaders. Just think back to WorldCom or Enron!

 If you want to make some serious money, you should not be buying the likes of General Electric Company (NYSE/GE) or American Express Company (NYSE/AXP). You should buy large-cap stocks if you are interested solely in dividends and minimal capital appreciation. The big money lies in the small- cap area, which continues to be underfollowed by Wall Street.

 Buy before the herd comes in, and you will do well. When the herd drives up the stock, it could be an opportune time to sell and move to the next trade. It’s in your best interest these days to think SMALL when you’re trading!