muffins14 wrote: ↑Thu Sep 03, 2020 5:39 pm
Steve Reading wrote: ↑Thu Sep 03, 2020 4:49 pm
Ex: Two firms, one twice as big as the other in every way (twice as much debt, twice as much book value, etc etc). The bigger company might be allowed to borrow twice as much, but it doesn't get to borrow any cheaper
just because it's bigger.
This surprises me. My intuition would be that Google could access capital much cheaper than a small company with much lower revenue-generation capability, no?
Ehm ok it's hard to explain over messaging. But let me repeat the core tenet: All fundamentals equal (same P/B, same gross profits over price, etc), a smaller or a bigger company should not produce higher or lower returns (which, in other words, means it should not pay more or less to raise equity capital or borrow).
Ex: Say Google is $1T. Now say there is some other company XYZ. This company is basically mini-Google, but simply 1000th the size in fundamentals. It has 1000th as much cash on hand. It has 1000th as much revenue and expenses. It's got 1000th the book value. It also has the same fundamental ratios (same P/E, same P/B, etc). So everything the same, but scaled down.
Now XYZ is about to IPO. What should be the market cap of this company?
Obviously, if the earnings are 1000th of Google and it has the same P/E, then its market cap should be $1B.
So this company, which is 1/1000th the size of Google in every fundamental measure, was able to obtain 1/1000th of cash for its IPO by selling the same number of shares. So it effectively raised equity capital at the same cost as Google did.
Historically, we don't see the above. Which means that historically, firms like XYZ, identical to their large cap peers in every fundamental way, actually had brighter and more profitable futures
, yet their market caps weren't reflecting it (i.e. they still only raised $1B). And that's how small caps, even once you control for fundamental factors, still outperformed.
"... so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary" - Paul Samuelson