The other day, a headline in a financial publication caught my attention. "Small Is No Longer Beautiful," it read.
I was intrigued. I knew all about the strength in small-cap stocks this past year and how their strong post-election rally started to fizzle in December. But would I go so far as to predict that these stocks have totally lost their appeal compared with their large and mega-cap peers?
I don't think so.
Yes, it's true that the Russell 2000, represented on the chart by the iShares Russell 2000 ETF (NYSE: IWM), strongly outperformed the S&P 500 (NYSE: SPY) index of U.S. large-cap stocks over the past year. And it might also be true that the index was getting a little ahead of itself, as suggested by its December pause.
Russell 2000 (IWM) Up Big Last Year
But I'm not interested in buying the index. In Game-Changing Stocks, my premium advisory, I am tasked with finding companies -- not indices -- that are poised to break rules, outgrow competition, become household names or start new trends. I scour the market for the top stocks to invest in to follow developing technologies and trends. And here, small caps carry some advantages.
Incredibly, even in our information age, small-cap companies still don't get enough coverage compared with their large-cap peers. Virtually no development can go unnoticed for larger tech firms like Apple (Nasdaq: AAPL) or Facebook (Nasdaq: FB). After all, more than 50 Wall Street analysts cover each company, not to mention TV and print journalists. On the other hand, major developments in many smaller companies can go unnoticed for quite some time. These firms simply fly under radar.
Small companies on the verge of technological breakthroughs or on the forefront of a new trend can be fully expected to benefit from another feature of the market: Money is still cheap to borrow. Large companies, especially tech leaders, have a lot of cash on their balance sheets. That could lead to a spree of mergers and acquisitions, which would be beneficial to the small caps being picked up.
Cash On Hand, Selected Large Caps
When large-cap companies have this much cash on hand, this means their ability to make money has exceeded their ability to be innovative. In such cases, buying smaller innovators is often the easiest path to new breakthroughs. All things considered, it's easy to predict that these tech giants' cash is going to provide long-term support to a period of strong merger-and-acquisition activity.
And even if I'm overestimating the willingness of these tech giants to buy their smaller peers, the mere fact that their cash balances have ballooned to these incredible amounts should serve as a support (or a "floor") under the smaller-cap companies' share prices, especially for those companies that prove themselves to be on the forefront of the newest and most disruptive technologies.
The rule-breakers and the game-changers are, therefore, likely to be in a position to leverage their achievements as their large- and mega-cap peers remain under pressure from the markets to deliver consistent quarterly earnings growth.
As a group, small caps are also set to benefit from other new developments that can make them some of the top stocks to invest in for 2017.
One of those benefits is the tax reform expected from the new administration. Smaller companies are likely to benefit more than the others from corporate tax cuts: These smaller organizations usually have no resources to utilize tax-avoidance schemes, and they are usually more domestically-oriented, so they have less reason to stash cash abroad.
Another reason for investors to continue concentrating in smaller-cap stocks is that there are literally thousands small-cap companies to choose from: The benchmark Russell 2000 Index contains 2,000 stocks, and there are also smaller, micro-capitalization stocks not included in the index. And that's even before we consider international small caps, such as MakeMyTrip (Nasdaq: MMYT).
Of course, mid-caps and even large-caps, if they present especially compelling cases, would not be off-limits, for me and my Game-Changing Stocks readers. Not all of them are disrupters, of course -- not all of them are even "growth" stocks. But my job is to find those that are, and then to figure out the potential of those companies, to identify and discuss early developments that are about to make them the top stocks to invest in.
Any way you look at it, I think it's clear that there's still a place for small-cap stocks in your portfolio. If you agree, then consider checking out my special report. It contains what my research staff and I consider to be the best opportunities for investors to profit from game-changing innovations in 2017 -- and beyond. To look it over, go here.