Fancy making a 4,500% return? There might be a better way to get rich

Investing in small-cap growth funds makes more sense than trying to find the next Amazon, financial experts say

Most investors will lose money trying to pick a big winner growth stock. Getty

Investing is a long-term business but sometimes it is impossible to resist the temptation to chase rapid short-term gains and turbocharge your overall returns.

While there is a slow-burning pleasure in building up a portfolio of solid, blue-chip dividend stocks, it is also nice to have a little excitement.

No investor can resist the allure of what might have been, if only they had bought the right growth stock at the right time.

This feeling was endemic during the technology boom, when investors tormented themselves with visions of buying, say, online retailer Amazon in 2001 for 35 cents, as its stock rocketed towards $175 some 20 years later.

That is an increase of 49,900 per cent, which would have turned $10,000 into more than $5 million.

We can dream, and we do. Which explains the appeal of Elon Musk’s electric car maker Tesla, the world’s fantasy stock in the latter stages of the technology boom.

New data from investment platform Saxo shows the stock is still up a stellar 1,057 per cent over the past five years. It turned $10,000 into $115,700, despite losing half its value over the past 12 months.

Yet, Tesla was not the best performer over five years. It came second to California-based solar power and battery storage specialist Enphase Energy, which soared by a staggering 4,501 per cent.

That would have turned $10,000 into $460,100, putting Tesla in the shade.

The technology sector has struggled lately, as the era of cheap money comes to an end and Silicon Valley companies lay off tens of thousands of workers, but it is still the breeding ground for big stock market winners.

New data from investment platform Saxo shows Tesla's stock is up 1,057 per cent over the past five years. Reuters

Biotech manufacturer ChemoMetec is the third best-performing global stock over five years, up 1,039 per cent, while processor and graphics company Advanced Micro Devices grew 875 per cent and Singapore’s global consumer internet company Sea rose 668 per cent.

Saxo’s research shows battery storage was the best-performing investment theme in the past five years, with renewable energy in second place.

While these numbers are dazzling, they are not particularly useful for investors.

Past performance figures are dangerous as they give investors a misleading idea of how these stocks may perform in the future.

Hindsight is a wonderful thing and “we all wish we could go back in time and pick the big winners”, says Anaam Raza, of investment platform Saxo.

The sad truth is we cannot and the majority of investors will lose money trying.

Many are giving up on growth stocks, given the bloodbath of the past year, yet Martin Romo, equity portfolio manager at The Growth Fund of America, reckons the market is “throwing the baby out with the bathwater”.

“It is essential to differentiate between companies that have reached the end of their runway or are facing stiffer competition with those that are simply in a cyclical slowdown,” he says.

Many companies will accelerate when the economy improves, and Mr Romo says the pace of innovation is picking up, particularly in artificial intelligence.

“Microsoft’s $10 billion investment in ChatGPT creator OpenAI is a recent example, but the push to develop innovative uses of AI is happening all around,” Mr Romo says.

Technology company Nvidia is already using AI to speed up product development while semiconductor maker Broadcom, which helped develop AI chips for Google in 2016, has since introduced more advanced AI chips, he says.

“This feels like the early days of mobile and cloud, just before they entered an era of hyper-charged growth.”

Others remain wary. David Philpotts, head of strategy at Schroders, warns that big names such as Facebook, Apple, Netflix, Meta, Amazon and Google are cheaper after recent falls, but far from bargains.

“Without their support, the US technology sector may no longer be the leading driver of stock market returns. Disruption is the norm but investors had it too easy identifying the winners for a short period of time,” he says.

For many, investing in growth stocks through an investment fund or exchange-traded fund makes more sense than trying to unearth the next Amazon or Enphase.

There are signs that the best-known way to play disruption — think fund manager Cathie Wood’s ARK Innovation ETF — is swinging back into favour. This fund achieved cult status during the technology boom only to fall by 40 per cent last year.

It is essential to differentiate between companies that have reached the end of their runway or are facing stiffer competition with those that are simply in a cyclical slowdown

Martin Romo,
equity portfolio manager at The Growth Fund of America

So far this year, it is up 29.13 per cent as its core themes of DNA technology, the genomic revolution, automation, robotics, energy storage, FinTech innovation and AI tempt investors again.

Small and micro-cap stocks can provide huge gains for investors but they come with substantial risks, says Russ Mould, investment director at AJ Bell.

“They tend to be more reliant upon one key product or service, one key executive or entrepreneur and one geographic market.”

If all goes well, the upside can be tremendous. “But if anything goes wrong, there is not much of a safety net, especially as young companies may not be profitable or generating cash, so their balance sheet may be less able to withstand any shocks,” Mr Mould says.

At worst, the fledgling company may simply fold, leaving investors with nothing.

“That’s why investors demand high returns from small caps, to compensate themselves for the higher risks involved,” he says.

Most private investors will want to spread the risk by investing in a smaller company or micro-cap fund, where a manager picks potential winners on your behalf, and spread the risk among dozens of companies.

It could be a good way to play the next stock market rally, when it finally comes.

We are not there yet, recent small-cap fund performance suggests. The Vanguard Small Cap Value ETF is down 9.8 per cent compared with 12 months ago.

Another popular smaller company ETF, BlackRock’s iShares Core S&P Small Cap, is down 8.9 per cent over one year and has edged up by only 1.41 per cent so far in 2023.

However, there are signs of life, with the Vanguard FTSE All World ex-US Small Cap ETF climbing 7.54 per cent year to date.

Smaller companies tend to struggle in a downturn, but lead the charge in a recovery.

Investors who are happy to take above-average risks in search of potentially above-average returns could allocate about 5 per cent of their equity portfolio to small caps, Mr Mould says.

“Cautious investors may allocate less,” he says.

That is a lot less exciting than going big on what you reckon is the next Enphase Energy but, ultimately, it could prove a lot more rewarding.

You will never receive a 4,500 per cent return from investing in a small-cap fund, but you should not lose the lot, either.