Flee Risk In... Small Caps?!
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- Published on Thursday, 14 June 2012 08:00
- Written by Ryan Cole, Editor, Small Cap Insider
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The common knock on small caps is risk. Yes -- they can provide unmatched returns when things go right, but they'll destroy a portfolio overnight when things go wrong... at least according to conventional wisdom.
Conventional wisdom is wrong.
The truth is, the small-cap universe is so diverse, and so large, that you can find some of the most boring, safe, income-earning companies there as well. In fact, in some cases, it's actually the small caps that are safer than the large ones.
Take banking.
As we've covered previously, large-cap banks are an absolute mess. As I type, JPMorgan (JPM:NYSE) CEO Jamie Dimon is testifying before Congress, dodging questions about the firm's recent $2 billion+ loss.
He's trying to make it sound like an isolated incident -- one with a few rogue traders who didn't know what they were doing.
Well, we'll agree with him on one point -- the traders had no idea what they were doing. But this was anything but an isolated incident.
It's just one in a long line of risky, highly leveraged moves that make up the bread and butter of transactions for large investment banks these days.
Two weeks ago in this space, I ran down all the ways big investment banks are losing market share to smaller competitors, in all sorts of traditional banking services -- from loans and mortgages to advisory services.
That's not what big banks do anymore. Instead, they take huge risks hoping for huge rewards... without, by their own admission, understanding the consequences of their actions.
Sounds more like what people assume for small-cap stocks, doesn't it? Big bets, maybe big rewards, but maybe big busts as well.
The biggest banks have been acting this way for years -- well before the banking crisis. That's just when the risks blew up in their faces.
Sanity in the Small-Cap Space
Meanwhile, there are a number of smaller banks -- many regional, many available in the small-cap space -- that are doing just what we thought our large banks were doing.
They are growing customer deposits at a slow, steady clip. They're increasing loans to businesses and individuals. They are handing out more mortgages, helping our real estate market recover. And they're doing all this without taking the crazy risks involved in buying up a Countrywide, or hedging against yourself using CDSs, or splitting loans up into such tiny slivers and divvying them out to separate instruments that no one knows where anything is anymore.
No -- if you want to find the best banks in America, you have to look at small caps.
In fact, according to American Banker magazine, the best-performing banks with less than $2 billion in assets perform over twice as well as their larger brethren -- and those with up to $10 billion perform nearly as well.
I'm talking about banks like CVB Financial (CVBF:NASDAQ) -- a holding company for Columbia Bank. It's up a "boring" 6.7% this year, while paying a quarterly dividend that yields over 3% annually. Its assets are 10 times as valuable as its debt, and income has been rising slowly but steadily year after year, quarter after quarter.
Boring. But much safer than its bigger brothers.
Or an even tinier bank -- Merchant's Bank, held by Merchants Bancshares (MBVT:NASDAQ). This is a microcap, with a cap under $200 million. Yet it gets the 10th best return on equity, again according to American Banker. And it pays over 4% in dividends each year.
Yes -- the truth is, small cap doesn't always mean risk. Sometimes -- like in the case of banks -- it can mean the exact opposite.
From the Inside,
Ryan Cole
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