Under ordinary circumstances, investors equate large companies with safety. With their roster of well-established businesses and well-known brand names, the blue-chip stocks that you know and love bring comfort to the most skittish of investors -- even in difficult times.
Now, though, the market has turned that common wisdom on its head. Today, large-cap companies seem the most vulnerable to the problems that this economic downturn has posed for corporate leaders and investors alike. Meanwhile, smaller companies could prove the best place to put your money right now.
The handicap of size
Big companies have plenty of competitive advantages over their smaller rivals. With their pricing power and economies of scale, the biggest players in an industry can often muscle out smaller rivals. Tactics such as price wars can often work even when an industry's top dog is less efficient than its competitors. Especially in businesses in which you find substantial barriers to entry that deter new competitors from challenging them, large companies can often successfully build big moats that help to ensure long-term profits and prosperity.
But in the current recession, many factors are working against big companies. They include:
- Access to capital. Typically, the bigger a company gets, the more capital it needs to sustain its business operations. Some companies, such as Microsoft (Nasdaq: MSFT ) and PepsiCo (NYSE: PEP ) , have enough cash and generate enough free cash flow that they don't need to rely on capital markets. But many big companies -- most notably financial firms such as JPMorgan Chase (NYSE: JPM ) -- have business models that require constant access to free-flowing money. That access hasn't been there lately, and stocks that were once thought completely safe have proved to be vulnerable.
- Flexibility. Unlike smaller competitors, big companies typically can't change their business strategies overnight. Having invested so much time, energy, and money to create a particular image, they can't remake themselves without undermining years of past efforts. General Motors (NYSE: GM ) , for example, is now struggling with the need to completely shift gears and attack a decades-old vehicle market from a different perspective -- and it faces big challenges in trying to get the job done.
- Growth. When panicked market sentiment finally gives way to hope for the future, companies with the best growth prospects will appeal the most to investors. Typically, large-cap companies have already seen their best growth -- while smaller competitors can position themselves more easily to take advantage of market trends to maximize growth.
The small-company answer
It's this strange combination of market conditions that make smaller companies much more attractive than their large-cap brethren right now. In particular, the small stocks that have retained promising opportunities for growth while maintaining conservative financial management and healthy amounts of liquidity will be the most likely to survive the recession and move upward in the recovery.
Here, for instance, are some promising candidates that have little or no debt along with good future growth prospects:
Sources: Yahoo! Finance; Capital IQ, a division of Standard and Poor's. Figures as of March 2.
Of course, if the economic downturn lasts long enough, no company is completely safe -- even those with strong defenses such as hefty cash holdings and strong balance sheets. But no matter when a recovery comes, these nimbler upstarts will have a big advantage over their more credit-dependent large-cap counterparts.
Stay safe
Now more than ever, it makes sense to look for safety in your stock investments. But safe doesn't always mean big. If you haven't taken a look at smaller companies because you thought they were too risky, think again -- you may find surprising strength in a place you least expected to see it.
For more on investing in a dangerous market:
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