A Sweet Spot for Profits

Here's the deal: Small-cap companies can be very profitable. There are times when they perform particularly well, especially when the economy is shaky, but even on an overall basis, they've often outperformed their larger counterparts. (Definitions vary widely, but small caps are defined by some as between $250 million and $1 billion in market cap, while mid-caps are between $1 billion and $5 billion.)

But let's not focus solely on the fact that small-cap companies and even some mid-cap companies can bring big benefits to your portfolio. Let's instead look at why this is so. I found two helpful comments from professional investors.

First off, Philip Tasho, CEO of investment firm TAMRO Capital Partners, has said that his most successful investments have been with companies about $200 million to $2 billion in size. "Small-cap investing can be more labor-intensive, [because of] the sheer number of companies, but at the same time you can more quickly know just about everything you need to know about a company to make an investment judgment."

It's true that the field is much bigger with smaller-caps than with big companies. After all, the S&P 500 sports companies with market-caps ranging from around ExxonMobil's $333 billion to as little as around $1 billion for some beaten-down stocks in the index. The Russell 2000, though, sports some 2,000 companies, with the largest member clocking in at less than $2.2 billion in market cap as of July 31.

Still, you can narrow the field down by screening. Here, for example, are some smaller companies I found via the screener in our Motley Fool CAPS community when I looked for companies with top five-star ratings, market caps between $200 million and $4 billion, and revenue and earnings growth of more than 10% over the past three years:

Data: Motley Fool CAPS.

Clearly, we'd need to do more research before investing -- but so far, these look like intriguing possibilities. Several have been highlighted by one or more of our investing newsletters or services -- so you could test drive those in order to read more of our analysts' thoughts.

More bang for the buck
Meanwhile, Robert Lietzow, CEO of Lakeway Capital Partners, has offered some additional thoughts on smaller companies. He has said that his sweet spot is companies valued around $2-3 billion, as they're "clearly established but can still be under the radar." He added that such companies can deliver more bang for the buck, as large caps simply can't sustain the growth rates that successful small and mid-sized companies enjoy early in their existence.

I think the table above supports that. Look at some of those growth rates -- you aren't likely to see ExxonMobil increasing its revenue by 40% annually any time soon. After all, you and I and our neighbors aren't going to suddenly need 40% more gas from year to year.

Simplify, simplify ...
Finally, remember Tasho's good point about how much easier it is to understand many small companies. Consider PetMed Express, for instance. It sells prescription drugs and other health products for pets. That's much easier for me to understand and evaluate than a company such as General Electric, with its many disparate businesses, such as aviation, lighting, health care, media, energy, finance, appliances, and more.

So consider the many merits of smaller companies. You may well find them not only easier to understand but also more lucrative to own.

Find some insights and ideas in these articles:

• Which Stocks Will Be 2020's 10-Baggers?
• These Stocks Can Easily Double Your Money
• These Will Be the Market's Next Big Movers