Buffett Was Right – Micro-Caps Smash The Overall Market

Buffett Was Right – Micro-Caps Smash The Overall Market

Are you ready for a bold claim?

At the 1999 Berkshire Hathaway annual shareholder meeting Warren Buffett said the following:

Shareholder: Recently, at Wharton, Mr. Buffett, you talked about the problems of compounding large sums of money. You were quoted in the local paper as saying that you’re confident that if you were working with a small sum closer to $1 million, you could compound capital at a 50% rate. For those of us not saddled with a $100 million problem, could you talk about what types of investments you’d be looking at and where in today’s market, you think significant inefficiencies exist?

Buffett: I may have been very slightly misquoted, but I certainly said something to that effect. I talked about how I polled this group of 60 or so people I get together with every couple of years as to what rate they think they can compound money at if they were investing small sums: $100,000, $1million, $100 million, $1 billion, etc. And I pointed out how the return expectations of the members of this group go very rapidly down the slope.

But it’s true. I could name half a dozen people that I think can compound $1 million at 50% per year — at least they’d have that return expectation — if they needed it. They’d have to give that $1 million their full attention. But they couldn’t compound $100 million or $1 billion at anything remotely like that rate.

…..I think working with a very small sum, there is an opportunity to earn very high returns.

Most fund managers struggle to beat the market. Over time the market (the S&P 500) has generated roughly an annualized return of approximately 10 percent.

Yet Buffett thinks that he and some of his compadres could compound cash at a rate of 50 percent with a very small portfolio?

We aren’t ever going to be able to prove or disprove Mr. Buffett’s bold claim. What I can verify however is that he is definitely correct in saying that small is the key to outperformance.

The data presented below is borrowed from the Center for Research in Security Prices. It breaks down the historical performance of the stock market by market capitalization decile.


There are a couple of observations that are easy to make from this data. One is that smaller is definitely better. The second is that really small is much, much better.

The smallest decile of stocks have nearly doubled the rate of return of the largest decile of stocks over the 90 year period ending in 2016.

Clearly, as investors we know where we should be looking for our investment ideas.