While the broader market has been choppy in the last year or so, small cap stocks have significantly outperformed the major blue chip indexes. The Russell 2000, the most common grouping of small cap equities, has returned +19% in the last 12 months – nearly double the +10% generated by the S&P 500 large cap index. Most recently as the market has rebounded since September 1, the Russell 2000 index has added +17% in a little under two months while the S&P has tacked on about +12%.
So what’s the appeal of small cap stocks — stocks like ARM Holdings (NASDAQ: ARMH)? Perhaps the largest selling point is that these are companies with much more growth potential than established blue chips. It’s infinitely simpler for a restaurant with just a few stores to grow its sales or revenue at an impressive 50% or 100% rate per quarter through rapid expansion – as opposed to a giant like McDonald’s (NYSE: MCD) that has very little room to grow. One report says the absolute farthest distance you can be from a McDonald’s location in America is just 115 miles!
Besides, even if MCD wanted to become even more ubiquitous, Wall Street is littered with the wreckage of companies that grew too widely and too quickly. Starbucks (NASDAQ: SBUX) and Krispy Kreme (NYSE: KKD) immediately spring to mind.
Clearly, small cap stocks are more nimble and able to tackle the market trends of the day more efficiently than big bureaucratic blue chips. They also have greater growth potential. But the catch is knowing when that exponential growth potential is starting to fade – or to put it another way, when a small company can no longer be called “small.” That is not to say there is no longer the potential for bigger sales and profits, but just that those gains will be less dramatic.
To help you figure out the tipping point for the surging small-caps in your portfolio, here is an in-depth analysis of ARM Holdings (NASDAQ: ARMH), a former small cap stocks that could be slowing down now that it is becoming an established large cap tech stock: