Small Companies, Big profits: a guide to investing in smaller companies
Investing in small shares raises all the issues associated with large and medium sized companies and many more besides. Smaller companies offer far greater opportunities for investors than larger ones.
Their shares may well be undervalued, perhaps significantly so, giving patient investors considerable scope for large capital gains as the rest of the stock market belatedly realises a small company’s real worth.
Smaller companies are more likely to attract takeover offers from larger ones, partly because they cost less to buy and partly because it is easier to persuade successful management to stay on within the larger group. Such takeovers will normally be at a premium to the prevailing stock market price.
If the company is not performing up to expectations there is a greater possibility of a management buyout. Risks of smaller companies are:
- Small companies often operate within just one sector, perhaps even have just one main customer, and they will rarely have overseas branches so they are vulnerable to the cycles of the UK economy generally and perhaps one part of it in particular.
- Small companies rarely attract the attention of fund managers who invest billions of pounds on the stock exchange, so their shares may not be traded actively. It can therefore be difficult to buy or sell at attractive prices.
- The smaller the company, the greater the chance that it is running at a loss and will need to raise money to keep going until the good times roll. It will therefore be more susceptible to its bank deciding to pull the plug or restrict its scope to chase business. It may need to come back to shareholders to raise more equity.
Many small companies have one substantial, possibly majority, shareholder. This may well be the founder who has retained control and who may be less suited to running a listed company than a private one. It will be difficult to attract highly experienced directors, especially executives who can earn higher salaries with larger companies. On the whole, therefore, smaller companies tend to offer greater risks but greater potential rewards than larger ones. While all investors should maintain a day-to-day watch on how the companies they have invested in are faring, the need is particularly pressing in the case of smaller companies. Stay alert, and there is great scope for success.
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