Traditional investing logic tells us that, when the economy turns sour like it has, we ought to flock to undervalued large-cap stocks because they not only have better access to capital than smaller companies do, but they also attract the smartest and brightest business minds.
If the recent market implosion has taught us anything, though, it's that a poorly run large company can fall harder than a poorly run small company in an unforgiving market. In fact, some small companies have adjusted much better than their larger counterparts.
Castles made of sand
Certainly there's still some merit in the conventional approach -- one could do far worse than buy quality names such as Procter & Gamble
Yet there was no shortage of talent wanting to get in the doors of Lehman Brothers, Wachovia, and Bear Stearns -- in fact, all three employers were among the 100 "most desirable" MBA employers in 2008, according to a Fortune survey. If traditional logic held true, this high-caliber talent should have been able to recognize their problems and correct them more quickly than a smaller company. As we all know, that reasoning failed many investors.
In fact, it's been the smaller and nimbler financial firms -- like Stifel Financial -- that have rolled with the market's punches. It avoided subprime exposure, and in February, Stifel reported that its investment bank increased quarterly net income by 29% year over year.
But it's not just the financials -- consistently poor execution at iconic American businesses like International Paper
Now compare those giant tales of woe to the success of PetMed Express
Bucking the dividend trend
Another reason investors traditionally turned to large caps in this type of environment was for their consistent and reliable dividends, but after 62 S&P 500 companies cut their payouts in 2008 -- followed by 41 so far in 2009, including Macy's
Indeed, in a conference call after the dividend cut, Macy's Chief Executive Terry J. Lundgren said, "We just believe that this is a time when nothing should be considered a sacred cow."
It's discouraging to see so many blue chip companies that have paid or raised dividends for decades suddenly change course and blame their mistakes on the microeconomic picture, but there are still companies out there -- large and small -- staying true to shareholders with dividend increases in this market.
One of those companies is $1 billion clothing retailer Buckle, who in November 2008, despite operating in the same consumer spending environment as Macy's, paid its shareholders a special one-time $3-per-share dividend and increased the quarterly dividend by 20%. Buckle is able to do this because it isn't burdened by debt (it has no long-term debt whatsoever), and it generates plenty of free cash flow, giving it plenty of room to raise dividends or reinvest in the business for the benefit of its shareholders.
Choose your weapons wisely
In a market where economic agility and strong management matter more than ever, make sure you're studying well-run small companies alongside larger companies. For my money, I want to own companies, regardless of size, that have a strong management team, have a rock-solid balance sheet, and dominate their market niche.
One of the companies I've been researching recently is Darling International
They're not only the largest and only publicly-traded company in this field, but they also have contractual relationships with big names like McDonald's
If you're looking for more small-cap ideas for this market, our Motley Fool Hidden Gems team can help. Among other things, they look for stocks that are:
- Underfollowed on Wall Street
- Led by dedicated founders
- Financially strong
- Dominant in their market niche
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Todd Wenning is an equal-opportunity investor. He owns shares of Procter & Gamble. Johnson & Johnson is a Motley Fool Income Investor recommendation, and Pfizer and International Paper are former recommendations. Pfizer is an Inside Value selection. The Fool owns shares of Procter & Gamble. The Fool's disclosure policy is as fast as greased lightning.