I’m a big believer that smaller can be better. My Subaru Outback lets me park in the teensiest spaces on Boston’s narrow streets. My small dog fits into a crate in the corner of the house, and a small suitcase lets me avoid the hassles of checking luggage.

And small cap stocks often offer huge gains to investors. At smaller companies the growth curves have typically just started, so one new product or distribution agreement can send revenue and earnings soaring. The stock market likes nothing better than wide open growth potential.

Yet smaller stocks hold more risk than their giant brethren and have fewer analysts following them, and so must be researched more carefully. My job as chief stock picker at Growth Stock Strategist: Find stocks small enough to experience tremendous growth but large enough to survive the inevitable squalls of the economy.

And given the sheer volume of small cap companies, my virtual trash barrel overflows with the tickers of stocks I’ve researched but discarded for not passing muster.

Current Portfolio

At Growth Stock Strategist I look for that potent balance of risk and reward, which most often can be found in smaller companies.

The stocks in our portfolio range from $260 million in market capitalization (numbers of shares times price per share) for Exactech, up to $4.6 billion for Gentex. This compares to a range of $100 million to $2.6 billion for stocks in the Russell 2000 and $1.7 billion to a hair-raising $539 billion for the S&P 500. Apple, the king of stocks, holds the prize for that $539 billion market cap.

I admit I have a soft spot for small- to mid-cap stocks. I love finding the critical ingredients of a company’s success and then tracking the company’s progress. Too often at a large company, an exciting development is buried beneath divisions and product lines. Rebuilding a company around a new technology is a time consuming and tedious procedure, as huge fixed expense structures take years to unwind, and breakhroughs are resisted by bureaucracy.

The concept of a small-cap premium, the idea that smaller firms have higher risk-adjusted returns, on average, than larger firms, has been questioned recently.  Portfolio managers argue that over the past five or 10 years the S&P 500 has delivered better compound returns than the Russell 2000, which is true.

But data from Ibbotson shows that small-cap stocks have a significantly higher compound annual return than large stocks over an extended period of time (see table).

While investors don’t hold stocks for the 88 years measured in the table here, the small-cap universe is the most fertile ground for big gains. Even when small caps in general are not performing, there are always pockets of small-cap stocks that will do well for shorter periods regardless of the market.

And this may be one of those times. Consider that big companies often have expanded globally, and that fluctuations in foreign currencies, such as the dollar’s strength in the last year, can squeeze profits from even the healthiest company.

But few small-cap stocks have big international businesses, so they avoid currency and global economic issues.

The global expansion currently hindering large-cap companies is an opportunity for growth at smaller companies. In addition, small-cap stocks are often led by founders and a team fully invested in the company’s success. Fewer layers of management and bureaucracy allow for nimble operations.

Stock Picker’s Paradise

So while almost everyone loves to compare their portfolio’s performance to an index, how performance is dispersed within that index offers huge potential for individual stock pickers, and that variation is much greater among small-cap stocks.

Although Growth Stock Strategist will never ignore a terrific stock idea because the stock is from a large company, most of our future names will fall within the market cap range of the current portfolio.

Caution

Even my Subaru makes me nervous sometimes. When I’m on the highway with 18-wheelers towering above me on all sides, I often wish for a Chevy Tahoe. Still, with the right amount of caution and preparation, small stocks, like my trusty Subaru, are worth the wild ride.