A Zebra in Lion Country: How Ralph Wanger Beat the Market with Small-Cap Stocks
A Zebra in Lion Country: The Dean Of Small Cap Stocks Explains How To Invest In Small Rapidly Growing Companies
If you are looking for a way to boost your investment returns and diversify your portfolio, you might want to consider investing in small-cap stocks. These are stocks of companies with a market capitalization of less than $2 billion. They are often overlooked by mainstream investors and analysts, but they can offer tremendous opportunities for growth and value.
A ZEBRA IN LION COUNTRY The Dean Of Small Cap Stocks Explains How To Invest In Small Rapidly G
But how do you find and invest in these hidden gems? How do you avoid the pitfalls and risks of investing in smaller companies? And what are some examples of successful small-cap stocks that have made their investors rich?
These are some of the questions that Ralph Wanger answers in his book A Zebra in Lion Country. Wanger is the founder and former manager of the Acorn Fund, one of the best-performing mutual funds in history. He specialized in investing in small, rapidly growing companies that had a competitive edge in their niche markets. He called these companies "zebras" because they stood out from the crowd and avoided being eaten by the "lions" - the large, established companies that dominated their industries.
In this book, Wanger shares his wisdom and experience as a veteran small-cap investor. He explains the principles and strategies of investing in small-cap stocks, as well as the challenges and risks involved. He also provides case studies of some of his most successful investments, such as Starbucks, Home Depot, Netflix, Costco, and Apple.
Whether you are a novice or a pro, this book will teach you how to survive and prosper in the investment jungle by finding and investing in zebras - the small-cap stocks that can deliver big returns.
Why invest in small-cap stocks?
Small-cap stocks have many advantages over large-cap stocks. Here are some of the benefits of investing in small-cap stocks:
Higher returns: Historically, small-cap stocks have outperformed large-cap stocks over the long term. According to Morningstar data, from 1926 to 2019, small-cap stocks returned an average of 12.1% annually, while large-cap stocks returned 10.1%. This means that $10,000 invested in small-cap stocks in 1926 would have grown to $1.3 billion by 2019, while the same amount invested in large-cap stocks would have grown to $264 million.
Diversification: Small-cap stocks tend to have low correlation with large-cap stocks, meaning that they do not move in the same direction or by the same magnitude. This reduces the overall risk and volatility of your portfolio, as well as enhances your returns. For example, during the dot-com crash of 2000-2002, when large-cap stocks lost 43%, small-cap stocks gained 14%. Similarly, during the financial crisis of 2008-2009, when large-cap stocks lost 51%, small-cap stocks lost 36%.
Growth potential: Small-cap stocks have more room to grow than large-cap stocks, as they are often in the early stages of their business cycle. They can benefit from new technologies, innovations, products, markets, and trends that can fuel their growth and profitability. They can also attract more attention from investors, analysts, and media as they grow and become more successful.
Undervaluation: Small-cap stocks are often undervalued by the market, as they are less followed and researched by analysts and investors. This creates opportunities for savvy investors to find bargains and buy them at a discount to their intrinsic value. Wanger calls this the "information gap" - the difference between what the market knows and what the investor knows. By doing your own homework and analysis, you can exploit this gap and profit from it.
How to find and evaluate small-cap stocks?
Not all small-cap stocks are created equal. Some are winners, some are losers, and some are frauds. How do you separate the wheat from the chaff? How do you find and evaluate the best small-cap stocks for your portfolio?
Wanger suggests using the following criteria for selecting small-cap stocks:
Strong management: The quality of the management team is crucial for any company, but especially for small companies that face more challenges and competition. You want to invest in companies that have visionary, competent, honest, and shareholder-friendly managers who can execute their strategy, overcome obstacles, and create value for their stakeholders.
Competitive advantage: The company should have a sustainable competitive advantage that gives it an edge over its rivals. This could be a unique product or service, a loyal customer base, a strong brand name, a low-cost structure, a superior technology, a patent or license, or a network effect. The competitive advantage should be difficult to replicate or imitate by competitors.
Niche market: The company should operate in a niche market that has high growth potential and low competition. The market should be large enough to support the company's growth, but not too large that it attracts the attention of larger competitors. The company should be a leader or a dominant player in its niche market.
Financial health: The company should have a sound financial position that allows it to fund its growth and weather any downturns. You want to look for companies that have positive cash flow, low debt, high return on equity, high profit margins, and consistent earnings growth.
Valuation: The company should be trading at a reasonable price relative to its earnings, sales, book value, cash flow, or growth prospects. You want to avoid paying too much for a stock, even if it has great potential. You want to buy low and sell high.
How to build and manage a small-cap portfolio?
Once you have found some promising small-cap stocks, how do you build and manage your portfolio? How do you allocate your capital among different stocks? How do you monitor your performance and adjust your holdings?
Wanger recommends using the following strategies for small-cap investing:
Diversify across sectors and styles: You should diversify your portfolio across different sectors (such as technology, health care, consumer discretionary) and styles (such as value, growth, momentum) to reduce your exposure to any single industry or factor. You should also diversify across different market caps (such as mid-cap and micro-cap) to capture different opportunities and risks.
Avoid herd mentality: You should avoid following the crowd or chasing hot trends or fads. You should think independently and do your own research and analysis. You should also avoid emotional biases such as fear or greed that can cloud your judgment and lead you to make irrational decisions.
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Rebalance periodically: You should rebalance your portfolio periodically (such as quarterly or annually) to maintain your desired asset allocation and risk level. You should also review your holdings and sell any stocks that no longer meet your criteria or have reached their fair value. You should also take profits or cut losses when necessary.
What are some examples of successful small-cap stocks?
To illustrate the power and potential of small-cap investing, Wanger provides some case studies of some of his most successful investments in his book. These are some of the companies that he invested in when they were small-cap stocks and that later became large-cap stocks or household names. Here are some of them:
Starbucks: Wanger invested in Starbucks in 1992, when it was a small regional coffee chain with a market cap of $220 million. He liked the company's strong brand name, loyal customer base, high growth potential, and visionary management led by Howard Schultz. He held the stock for 10 years and sold it in 2002, when it had a market cap of $11 billion and over 5,000 stores worldwide.
Home Depot: Wanger invested in Home Depot in 1981, when it was a small home improvement retailer with a market cap of $25 million. He liked the company's innovative business model, low-cost structure, niche market, and aggressive expansion strategy. He held the stock for 17 years and sold it in 1998, when it had a market cap of $100 billion and over 1,000 stores across the US.
Netflix: Wanger invested in Netflix in 2002, when it was a small online DVD rental service with a market cap of $300 million. He liked the company's disruptive technology, subscription model, customer satisfaction, and growth potential. He held the stock for 11 years and sold it in 2013, when it had a market cap of $20 billion and over 40 million subscribers worldwide.
Costco: Wanger invested in Costco in 1985, when it was a small warehouse club retailer with a market cap of $300 million. He liked the company's low-price strategy, loyal membership base, high sales volume, and efficient operations. He held the stock for 14 years and sold it in 1999, when it had a market cap of $18 billion and over 300 stores worldwide.
Apple: Wanger invested in Apple in 2003, when it was a small computer maker with a market cap of $6 billion. He liked the company's innovative products, loyal fan base, niche market, and visionary management led by Steve Jobs. He held the stock for 9 years and sold it in 2012, when it had a market cap of $600 billion and was the world's most valuable company.
What are some challenges and risks of small-cap investing?
Small-cap investing is not without its challenges and risks. There are some drawbacks and pitfalls that you need to be aware of and avoid when investing in small-cap stocks. Here are some of them:
Higher volatility: Small-cap stocks tend to be more volatile than large-cap stocks, meaning that they can experience larger price swings and fluctuations. This can increase the risk and uncertainty of your investments, as well as affect your emotions and psychology. You need to have a high tolerance for risk and volatility to invest in small-cap stocks.
Lower liquidity: Small-cap stocks tend to have lower liquidity than large-cap stocks, meaning that they have lower trading volume and fewer buyers and sellers. This can make it harder to buy or sell your stocks at your desired price or time. It can also increase the bid-ask spread (the difference between the highest price someone is willing to pay and the lowest price someone is willing to sell) and transaction costs.
Less information: Small-cap stocks tend to have less information available than large-cap stocks, meaning that they have less coverage and research by analysts and media. This can make it harder to find reliable and accurate data and analysis about the company's performance, financials, prospects, and risks. It can also increase the information gap and the possibility of missing important news or events.
More frauds and scams: Small-cap stocks tend to have more frauds and scams than large-cap stocks, meaning that they have more cases of manipulation, deception, misrepresentation, or illegal activity by the company's management, insiders, or outsiders. This can result in huge losses or wipeouts for unsuspecting investors. You need to be careful and vigilant when investing in small-cap stocks and avoid any red flags or warning signs.
What are some resources and tools for small-cap investors?
If you are interested in investing in small-cap stocks, you will need some resources and tools to help you find, evaluate, and monitor your investments. Here are some of the sources of information and analysis that Wanger recommends for small-cap investors:
Newsletters: Newsletters are publications that provide recommendations, analysis, and commentary on specific stocks or sectors. They can help you discover new ideas, learn from experts, and stay updated on the market trends and developments. Some of the newsletters that Wanger likes are The Prudent Speculator, The Turnaround Letter, The Value Line Investment Survey, and The Motley Fool.
Magazines: Magazines are publications that provide general information, news, stories, and features on various topics related to investing and finance. They can help you broaden your knowledge, gain insights, and get inspired by successful investors and entrepreneurs. Some of the magazines that Wanger reads are Barron's, Forbes, Fortune, BusinessWeek, and Inc..
Websites: Websites are online platforms that provide data, tools, charts, reports, forums, and blogs on various aspects of investing and finance. They can help you access real-time information, perform research and analysis, compare and screen stocks, track your portfolio, and interact with other investors. Some of the websites that Wanger uses are Morningstar, Yahoo Finance, Google Finance, Zacks, and Seeking Alpha.
Blogs: Blogs are online journals or diaries that provide personal opinions, experiences, tips, and advice on various topics related to investing and finance. They can help you learn from different perspectives, get practical guidance, and follow the journeys of other investors. Some of the blogs that Wanger follows are A Wealth of Common Sense, The Reformed Broker, The Irrelevant Investor, A Random Walk Down Wall Street, and The Intelligent Investor.
Podcasts: Podcasts are audio or video programs that provide interviews, discussions, stories, and lessons on various topics related to investing and finance. They can help you listen to experts, get insights, and stay informed on the latest news and trends. Some of the podcasts that Wanger listens to are The Investors Podcast, We Study Billionaires, Motley Fool Money, MarketFoolery, and Masters in Business.
Conclusion: Key takeaways from the book and the author's advice
In conclusion, A Zebra in Lion Country is a great book for anyone who wants to learn how to invest in small-cap stocks. The book covers the benefits, challenges, strategies, criteria, examples, and resources of small-cap investing. It also provides valuable insights and advice from one of the most successful small-cap investors of all time - Ralph Wanger.
Here are some of the key takeaways from the book and the author's advice:
Small-cap stocks can offer higher returns, diversification, growth potential, and undervaluation than large-cap stocks.
You should look for small-cap stocks that have strong management, competitive advantage, niche market, financial health, and reasonable valuation.
You should diversify your portfolio across sectors and styles, avoid herd mentality, be patient and long-term oriented, and rebalance periodically.
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You should use newsletters, magazines, websites, blogs, and podcasts as sources of information and analysis for small-cap investing.
Wanger's final advice for small-cap investors is to be zebras in lion country - to stand out from the crowd, avoid being eaten by the lions, and find and invest in the best small-cap stocks that can deliver big returns.
FAQs
Here are some frequently asked questions about the book and small-cap investing:
What is the difference between small-cap, mid-cap, and large-cap stocks?
Small-cap, mid-cap, and large-cap stocks are classifications of stocks based on their market capitalization, which is the total value of all the shares of a company. Generally, small-cap stocks have a market cap of less than $2 billion, mid-cap stocks have a market cap of between $2 billion and $10 billion, and large-cap stocks have a market cap of more than $10 billion.
What are some of the best small-cap mutual funds or ETFs to invest in?
There are many small-cap mutual funds or ETFs that you can invest in to gain exposure to a diversified basket of small-cap stocks. Some of the best ones according to Morningstar ratings are Vanguard Small-Cap Index Fund, iShares Core S&P Small-Cap ETF, Fidelity Small Cap Growth Fund, T. Rowe Price QM US Small-Cap Growth Equity Fund, and Acorn Fund.
What are some of the current trends or opportunities in small-cap investing?
Some of the current trends or opportunities in small-cap investing are related to the recovery from the COVID-19 pandemic, the shift to digitalization and e-commerce, the rise of renewable energy and electric vehicles, the innovation in biotechnology and health care, and the emergence of new markets and consumers.
What are some of the common mistakes or pitfalls to avoid when investing in small-cap stocks?
Some of the common mistakes or pitfalls to avoid when investing in small-cap stocks are buying too late or selling too early, chasing hot or hyped stocks, ignoring fundamentals or valuation, overpaying for fees or commissions, neglecting diversification or risk management, and falling for scams or frauds.
Where can I buy or sell small-cap stocks?
You can buy or sell small-cap stocks through any online brokerage platform that offers access to the stock market. You will need to open an account, fund it with money, and place your orders. Some of the popular online brokers that offer low-cost and user-friendly services are Robinhood, E-Trade, Fidelity, Schwab, and TDAmeritrade.
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