Warren Buffett said small investors have a growth advantage over huge investment accounts. Today we discuss 6 Small investor advantages Warren Buffett knows and how that can be.
Investing becomes a numbers game when you or Warren Buffett are considering an investment opportunity. The opportunity must offer difference making potential to a portfolio.
This post is Part 1 of the 2 part White Top View Series: Small Investor Advantages.
For this discussion, about how small investor advantages can produce better returns, we set aside any consideration for diversification or safety. But just for now. We cover the why, how and where of diversification and safety in other discussions.
Small investor advantages Warren Buffett knows include
advantages over monster sized investment funds
Returns make a big difference
Oh yes! Size matters!
Faster growth numbers
Playing the pecking order
New listings and startups
Returns make a big difference
When you look at a prospective investment you need to know you have good odds of making a reasonable return. The possible investment worth of the portfolio must increase by a meaningful amount. When the potential returns are too small, it is simply not worth considering the investment.
A $1,000 investment realising a 25% return, sounds like a good solid result. That $250 return is particularly good if $1,000 is the entire portfolio! Under normal circumstances, a 25% return is excellent!
However, if that $1,000 investment is part of a $1,000,000 portfolio, the $250 gain increases the total account by 0.0025%! Not much! And certainly not worth making. That return is like earning a quarter ($0.25) in a $1000 portfolio, or a return of $1 on a $4,000 portfolio. Such returns are so small that the gain is meaningless.
The challenge of the huge portfolio
When the portfolio is huge, investment size presents a challenge. In relative terms, small investments can not work for very large portfolios. Huge funds need big results from big investments to produce acceptable returns and meaningful growth. A multiple billion dollar portfolio needs gains from very big investment positions to make any real difference.
So like Mr. Buffett, before we invest, potential return numbers must show reasonable gains. To do so, managers of huge portfolios certainly face the very tough challenge of producing consistent and meaningful growth.
That gives us small players an important advantage. Remember, small is relative. In investing scale, small still includes portfolios holding many millions. So even beginners starting with a small stash are keeping some very good company!
Oh yes, investor! Size matters!
For a little context, small companies in U.S. markets are those under $1 billion in market capitalization!
Market capitalization of a company is the price of a share times the total number of shares outstanding. For example, a company with 100 million shares issued, that trades at $20 per share, has a market capitalization of 100,000,000 X $20 = $2,000,000,000!
That’s 9 zeros after the 2; that’s $2 billion! Lots of money, but in the stock market, our example company sits at the lower end of the large company list!
Now consider the dilemma of an investment manager running a company worth many billions. They must find and make big investments in very big companies to produce good investment outcomes.
Warren Buffett manages a giant company of huge value. His company, Berkshire Hathaway usually sits in the middle of the list of the top 10 largest companies by capitalization.
Small investors can beat monster sized funds
With over $300 billion, as Warren Buffett has in the value of his Berkshire Hathaway, he can not consider small investments in small companies. Mr. Buffett seeks big plays in very big companies. He has to find and go huge in huge companies or pass the investment opportunity.
Such a problem, investing $330 billion! He can’t consider many excellent investment opportunities that are available to us! Imagine, our investment advantage over Warren Buffett! In fact size gives us a very distinct advantage! In practical terms this means we have no huge players pushing up prices and sucking up all the shares of companies that we want.
That leaves us many more investment opportunities to pick from! It also means that we can search the huge pool of companies for spectacular performers and rapidly growing opportunities. Such companies are far too small for Mr. Buffett to consider. He must pass and leave them for us!
As smaller investors, we can consider all companies from the largest that he may consider, to those that rank as less than huge and all the way down to the smallest venture companies that may prove to be big winners. Providing the a company meets our investment criteria, we can feast on the shares while the big investment funds must pass them by or even better, buy them from us when they grow into big companies!
This reality of small and large account management, lets us grow to become big fish in our own little pond. And we can freely hop from pond to pond or market to market around the world. Our size gives us great financial flexibility the huge players can not have!
Faster growth for bigger returns
Another aspect of the financial numbers also works very well for us. Growing a company from a $10 million to $20 million or even $100 million to $200 million is easier than doubling the size of multiple billion dollar behemoths.
Also, smaller company growth can, and often does, happen relatively fast. Presuming that we do our homework and buy quality growing companies, the effect on our portfolios can be dramatic. We can grow far faster than any index. It requires risk management and homework, but it can be done well.
Among rapidly growing companies, as the size increases the rate of growth most often slows. This is the simple challenge of keeping all the complex parts of a growing enterprise working well together as it gets significantly larger.
These comments are guidelines, not absolutes. However, in this context, the odds favor us. Riding growth gives us a way to handily outperform not only the market indexes but outpace managers of monster sized funds as well.
Next time our discussion on small investor advantages Warren Buffett knows, Part 2: 3 More Small Investor Advantages discusses liquidity, playing the market pecking order as well as new listings and startups.
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These discussions and information intend to help you better understand markets and investing. I am not a financial or investment advisor; opinions are for informational and educational purposes only and are not intended as investment advice. For syndication of the site or blog, please contact info@WhiteTopInvestor.com. © 2014 Bryan Kelly