In small cap you have a plethora of names, a lot of companies, and they’re generally earlier in their growth cycle. So, it’s not as proven; there’s more thinking about what this company could be in the future.
Both Apple and Amazon were considered small caps about 20 years ago or so. And today they’re some of the biggest companies in the world.
Small cap has a number of inefficiencies. One of the inefficiencies is just a time arbitrage, a company that can actually compound growth at a higher-than-expected rate or more durably than what the market that’s focused simply on near term prospects.
We’re willing to look beyond 90-day reporting increments and more toward three-, four-, or five-year time frames when we’re trying to ascertain how large a company’s earnings stream can grow.
Another one is fallen quality growth. So, growth is not linear. The reality is that almost every company stumbles. And if you’ve done your work ahead of time to understand how strong the competitive position is, how durable the business is, and when that blip happens—that stumble and the stock reacts—you have the opportunity to step in and buy very attractive prices.
The last are undiscovered quality growth companies. These tend to be a little more unique to the smaller-cap spectrum—companies that aren’t well covered by the street; maybe they don’t have much institutional ownership. And people haven’t been to the offices to visit these companies and understand what they’re doing, how they’re doing the business, how the business is changing.
Finding information in small cap can be different than larger-cap companies. Sometimes they aren’t covered by a sell-side analyst.
It means that when we find something unique, perhaps it’s actually unique and special as opposed to something that everyone has already acknowledged.
Well, with any investment decision, there are numerous factors to consider. But I feel that there are three that are paramount. First, there needs to be a very large market opportunity. Second, the company has to provide a product or service that has a high value proposition to its clients. And third, the competitive barriers have to be very strong and that we feel confident will stand the test of time.
When these factors line up, it gives us the ability to look at the long-term horizon for a company and really try to ascertain the long-term earnings power. The extra time and effort we put in on the front end gives us that confidence, which we believe helps us add alpha for our clients.
Filmed September 2018
The views and opinions expressed herein are those of the speakers as of the date of publication, are subject to change without notice as economic and market conditions dictate, and may not reflect the views and opinions of other investment teams within William Blair. Factual information has been obtained from sources we believe to be reliable, but its accuracy, completeness, or interpretation cannot be guaranteed. This material may include estimates, outlooks, projections, and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. This video has been provided for informational purposes only and should not be considered as investment advice or a recommendation of any particular strategy or investment product, or as an offer to buy or sell any securities or related financial instruments in any jurisdiction. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions. Investing involves risks, including the possible loss of principal. Equity securities may decline in value due to both real and perceived general market, economic, and industry conditions. The securities of smaller companies may be more volatile and less liquid than securities of larger companies. Diversification does not ensure against loss. Any investment or strategy mentioned herein may not be suitable for every investor. The Russell Top 200 Index is a market capitalization-weighted index designed to represent the largest companies in the U.S. equity universe. The Russell 2000 Index is a market capitalization-weighted index designed to represent the small cap segment of the U.S. equity universe.
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