What Do Investors Need to Know About Small Caps?

TL;DR

Small caps are currently undervalued and have the potential to outperform, especially in an inflationary environment due to their pricing power, focus on B2B, and historical track record.

Transcript

small caps as i you know mentioned or alluded to i think they were kind of this forgotten asset class you know they are selling at about a 20 discount um to large caps um and it's typically a premium we we typically see small caps trade at a premium and now we're seeing them sell at a significant discount and it goes back to this idea that people r... Read More

Key Insights

• 👲 Small caps are currently undervalued and sell at a discount compared to large caps in the market.
• 👲 Small caps have a historical track record of outperforming in inflationary times.
• ✊ Small cap businesses have pricing power and flexibility, particularly in B2B industries.
• 👻 The COVID-19 pandemic has allowed small caps to improve their operations and technology capabilities.
• 😮 Rising interest rates could lead to a rotation away from tech stocks towards small caps.
• 👲 Small caps should be evaluated based on their cash flow, earnings, and ability to give back to shareholders.
• 🫰 The Russell 2000 index, which represents small caps, contains companies with varying levels of earnings. It is important to focus on businesses with real earnings and potential for growth.

Questions & Answers

Q: Why are small caps currently undervalued compared to large caps?

Small caps are currently selling at a discount because they have been overlooked by investors for a while and have underperformed large caps. However, this presents an opportunity for investors to benefit from their potential upside in the future.

Q: Are small caps more resilient in an inflationary environment?

Yes, small caps have historically beaten inflation in every decade since the 1930s. They have pricing power and are more focused on B2B interactions, which allows them to pass along pricing increases and be less exposed to consumer demand pressures.

Q: How do small caps deal with inflation and rising interest rates?

While small caps are not completely immune to demand pressures and higher borrowing costs, many high-quality small cap businesses have used the COVID-19 period to become more efficient and resilient. They have improved their technology and automation capabilities, which can help them navigate inflationary pressures effectively.

Q: Are small cap businesses overleveraged?

Contrary to popular belief, not all small cap businesses are overleveraged. In fact, many small caps do not rely heavily on access to capital markets and have strong balance sheets. They prioritize operating leverage over financial leverage and focus on generating cash flow and dividends for their shareholders.

Summary & Key Takeaways

• Small caps are currently selling at a 20% discount compared to large caps, which is unusual as small caps typically trade at a premium.

• Despite underperforming large caps in recent years, small caps have historically beaten inflation in every decade since the 1930s.

• Small cap businesses have pricing power and resilience in inflationary times, especially if they are focused on B2B interactions and have improved during the COVID-19 pandemic.