Small cap stocks have consistently outperformed their large company peers by significant margins since Truman was president. The smallest companies tracked by Data Driven Investing earned a 17.5% compounded annual return from 1951 to 2002, as opposed to a 10.1% compounded return for the 100 largest. For someone investing $5000 in an IRA at age 30 (and nothing more), this gap between returns could mean the difference between having $1,413,498 (if we ignore brokerage commissions, which shouldn’t be more than $10 a trade) and $145,053 by age 65.

Moreover, certain types of small cap companies have provided particularly strong returns – especially those with reasonable ratios of market cap to sales, earnings, and tangible book value.

Institutions and other big investors know this, but when they set out to buy 100,000 shares of a thinly traded $10 stock, the 100,000th share can easily cost them $11, $12, or more – and selling 100,000 shares of that same stock can drive its price down several dollars per share.

Small investors, on the other hand, can usually buy and sell a few hundred shares of the same thinly traded stock without causing the price to spike or plummet. 

 

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