We live in a society where size matters, to the detriment of most of those who focus on it. Our culture encourages a bigger house. The rich and famous are celebrated for having trophy houses all over the world, and numerous cars to go with each one. As wonderful as all those things are, they come with their share of headaches.
Even in investing, size is viewed as an asset when in fact it is more of a liability. Business history is littered with numerous multi-billion dollar mega deals that were praised only to unravel years later, having destroyed value in the process. Yet investment funds are often selected based on asset size, in addition to performance.
The reality is that size is an impediment to investing. Investor money is aggregated into mutual funds and pension funds that have to invest billions of dollars. Many U.S. companies who spend years conglomerating numerous businesses in order to get bigger are now breaking up into smaller pieces, having shifted from thinking that bigger is always better.
To be sure, investment performance is what matters, and money follows performances. But the consequence of that is that scale often comes with decreasing returns. Berkshire Hathaway (BRK.A; BRK.B), perhaps the greatest compounding vehicle over the last 50 years, is a perfect example. During the late 1970s and early 80s, Berkshire shares were compounding at a nearly 60% annual clip. For 15 years prior to that date, Warren Buffett compounded money at nearly 30% per annum running the Buffett Partnerships.
For years, Buffett has been saying that Berkshire's future returns will not come close to matching past performance, and he is right. While Buffett continues to get better, the enormity of the money Berkshire has to deploy -- tens of billions a year -- limits the type of investments Berkshire can make to very large elephants, which tend to be more efficiently priced.
Consider micro cap Espey Manufacturing and Electronics (ESP), a supplier of electronic equipment to the military industry. The company has a $60 million market cap, nearly $20 million cash, zero debt, and a yield of 4%. It makes money, generates cash flow, and operates under the radar, since 99% of investment capital won't touch a $60 million market cap company. Shares are up over 10% this year, including the dividend yield. And this is not hindsight -- I've mentioned this company before.
RF Industries (RFIL) is another high quality micro-cap. This $38 million provider of cable assemblies, specialized connectors, and other specialized wiring and cable needs is also debt-free, consistently makes money, and yields over 6%. Since the majority of investment capital can't even look at a company of this size, smaller funds and investors can take advantage of the opportunity that others cannot.
To be sure, size can matter with respect to solvency. Many micro cap companies can quickly perish under difficult economic conditions that bigger, stronger companies can withstand. But as an investor, the goal is to analyze any opportunity, big or small, and apply the same standard and rigor to finding attractive investment ideas. In some cases, smaller can be better.