“Size is the anchor or performance. There is no question about it. It doesn’t mean you can’t do better than average when you get larger, but the margin shrinks.” -Warren Buffett
Contrary to what you’ve heard … size matters. Especially when it comes to investing.
Warren Buffett was once asked what approach he would take if he were managing millions instead of tens of billions of dollars. Would he invest in more Graham-type stocks—low P/E stocks—or large franchise stocks, as he is currently doing?
Buffett responded that he would be more inclined to invest in “what you might call Graham stocks.” He continued by saying he would do “far better percentage-wise” if he were working with a small sum of money.
That’s a bold statement coming from a person who has been able to compound money by 20% per year for almost half a century! Buffett told a magazine reporter, “I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
The reason he is confident that he would have better returns managing small sums of money is because of the opportunities available to him. Instead, as a large-sum investor he is faced with “relatively few possibilities in the investment world that can make a real difference in our net worth.”
The small-sum investor has “thousands and thousands of potential opportunities” while the large-sum investor has a much narrower universe to select from. Buffett concluded by saying, “So, you have a huge advantage over me if you’re working with very little money.”
When Buffett started managing money in the 1950s, he wasn’t buying large-cap multinational companies like Coca-Cola and Johnson & Johnson. Instead, his portfolio was filled with companies he found while leafing through the pages of Moody’s Manual. He was looking for stocks that were statistical bargains. His portfolio was filled with stock such as Western Insurance Securities, Grinnell Corp. and the textile company Berkshire Hathaway (BRK.A)(BRK.B)
The only thing these stocks had in common was that they were all purchased at cheap valuations to the underlying worth of their business.
His results, when he managed small sums in his Buffett Partnership (BP), were truly amazing. From 1957 through 1968 the Dow Jones annual compounded rate was 9.1%, compared to BP’s limited partner’s return of 25.3%. Over a 10-year span, Buffett, working with relatively small sums of money, was able to almost triple the Dow Jones return … and he never had a losing year.
The majority of investors, unlike institutions and large hedge funds, have no limitations on what they can buy.
By not managing large sums of money, most investors are able to take advantage of Mr. Market’s mispricing and add high-quality companies purchased at bargain prices. While many large-money managers might have seen the same opportunities, they weren’t able to invest in them.
A money manager, with $2 billion of assets under management, has a much more limited universe to invest in than we do. If the minimum investment they would make in any one stock were 5% or $100 million, they would only be able to select from stocks with a market cap greater than $2 billion. Otherwise they would find it difficult to buy or sell shares due to their size.
Where Institutions Can’t Tread
Small-cap stocks (less than $2 billion in market cap) are not as widely followed by Wall Street analysts. Since large-money managers can’t invest in them and would not generate any trading commissions for the brokerage firms, analysts focus elsewhere.
Their loss is our gain.
Here are a few companies with market caps less than $2 billion that have strong balance sheets and are currently trading at bargain prices:
|Stock||Ticker||3/21/13 Price||P/E||EV/EBIT||SE/TA||Market Cap|
|Cirrus Logic, Inc.||CRUS||$22.83||10||7.8||0.80||$1,499|
|Mantech International Corp||MANT||$26.38||10||4.5||0.63||$983|
|Kulicke & Soffa||KLIC||$10.83||5||1.6||0.85||$826|
NOTE: SE/TA (Shareholder Equity-to-Total Asset Ratio: Ratio used to determine the value that shareholders would receive if the event the company liquidated. To be considered financially sound, a company should own at least twice what it owes for a ratio of .50 or greater.
 Amey Stone, “Homespun Wisdom from the ‘Oracle of Omaha’,” BusinessWeek 25 Jun 1999, Print.