Question

Discuss why the stocks of small firms might outperform large firms over long periods of time? Will be true over short periods of time, too?

Answer 1

• Small Firms Stock will outperform large firm stock in long run because they are creating their market value in long run business which help investor in wealth maximization during long period of time whereas Large firm stock are already having greater market cap. which create wealth to investors in slow & study manner as compare to small size firm.
• Since small firms are more risk averse and provide greater investment return so investor who are willing to take risk in long run time use to invest in small firms whereas investors which are less risk averse will always tends to invest in large size firms.
• Eg Let say a small firm which is having revenue of 50000 in 1st year of operation and a large firm which is having 1000000 as revenue in 10 th year of operation.Now in next year revenue of small firm comes out to be say 80000 i.e. 60% increment and revenue of large firm in next year is say 1100000 , then it will be grown up by 10% , which is far lower than small firm.

Stocks of small firms might outperform large firms in large run but it cannot be outperform large firms in short run because Large Firm is having better market value, success running business models, better clientele,better financial leverages,higher liquidity and many other factor which are better off in large firms as compare to small firms.

As an investor view point, Investment should be diversified in both small and large cap stock i.e. to create a portfolio to increase return and to minimize risk.