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Sizing up stock investments

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When seeking balance between risk and return, investors should consider the market capitalization of stocks and stock funds in their investment portfolios. In a Money Talk Video, Brian Kilb explains why it’s important to diversify the size of companies you invest in.

Joel Dresang: Brian, when we talk about diversifying the stock side of an investment portfolio, we sometimes talk about caps – small caps, large caps. What does that mean?

Brian Kilb: Caps refers to capitalization, Joel. Market capitalization is, in essence, the size of equity in a corporation. Equity would relate to the number of outstanding shares times the price per share. Market capitalization, as it’s used to differentiate a portfolio, is just differentiating between larger companies and smaller companies.

Joel: Is there a cutoff point that they usually use as guidelines for what’s small and what’s large?

Brian: Sure. Different people will objectively measure things in different ways. But Morningstar, for instance, a resource that we use frequently, defines small caps as equity under $1 billion, larger companies as total market capitalization in excess of $8 billion.

Joel: What are some of the characteristics of small-cap companies?

Brian: Well, smaller companies are more nimble. They’re the PT boat in the fleet. The larger caps are the big aircraft carriers.

And as economic conditions change, smaller companies are oftentimes more able to adapt quickly to those changes. Typically, you’ll find in a changing business cycle that the small caps, because they can adapt quicker, are often quicker out of the gate. So we like small caps typically in the beginning of the business cycle because they’re first to do new things, to be innovative and to take advantage of changing market conditions.

Joel: What about the large caps? What are some of their tendencies?

Brian: Well, the larger companies typically take over the markets in the latter part of the business cycle. So these are bigger companies, but they have more girth. They have more resources. They have the ability to withstand changing conditions better. So the latter half of the business cycle typically favor larger companies. More defensive conditions typically favor larger companies.

As a rule, the smaller companies are more expensive. So I think a couple of things you want to pay attention to when you’re differentiating between smaller companies and larger companies: Where are we in the business cycle? And where are we from a valuation standpoint?

Joel: Is it true that the larger cap are also more global, that you’re less likely to see small-cap companies exporting, for instance?

Brian: That’s a great point as well. It would be typical for a smaller domestic company not to do a lot of business outside of our own borders. The larger, global multinationals have far-reaching business environments. That can be both good and bad. When things are difficult overseas, the bigger companies oftentimes are dragged down by that foreign exposure. The smaller companies are able to adapt domestically to changing environments.

Joel: What about mid-cap companies? Where are they? I know, they fall in between.

Brian: But I think it’s a good question. Whatever makes the smaller companies attractive or unattractive, money will migrate from the small to the large or the large to the small, depending on what conditions are. The mid-caps are the resting place in between.

Joel: And we’re not talking either-or here. It’s not you have one of these. It’s nice to have a mix.

Brian: We’re talking about an emphasis. You should never over-allocate practically to any asset category.

Joel: So it’s always good to have some amount of small-, mid- and large-cap.

Brian: Absolutely.

Brian Kilb is executive vice president and chief operating officer of Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May

 

(initially posted April 29, 2014)

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