The Sweet Spot for Big Returns

To kick off this week for HX Daily, we have written highlights from our great conversation with my old friend and colleague Ram Parameswaran of Octahedron Capital.

We have been effusive in our praise of him and what we learned from him about his process, so we will not elaborate on those points further.

One aspect of our conversation was so impactful that it deserved its entire issue of HX Daily.

The topic was what the "sweet spot" is to be able to deliver the absolute best returns.

Ram had a straightforward point – for BIG returns, he likes to look at companies with a market capitalization between $10 billion and $50 billion.

Click here to check out Enrique Abeyta’s conversation with Ram P from Octahedron Capital on the HX Podcast if you haven’t already, or watch below!

This is a straightforward concept, but there are many levels to it, and they are worth discussing.

The first topic is what we mean by "big" returns.

His core strategy is very similar to our strategy for our INVESTING publication HX Legacy, where we are looking for a minimum of a "double." Our fundamental goal is to find stocks that can go up three- to five times.

Look – we are still aiming for stocks that can go up ten times, but we think the above return profile is a great return and happens much more often.

The next question would then be, why not smaller companies?

It would seem like it doesn't take much for a "micro" capitalization company with a market cap of $20 million to $100 million to go up a lot. With those, you can imagine potential returns of twenty, thirty, or even one hundred times.

The issue is the risk and the likelihood of seeing that kind of return.

While the math of market capitalization makes it more accessible, the reality is that these companies are sub-scale and don't have the same access to resources as larger companies.

Even companies with a market capitalization of several billion may not have the scale to "de-risk" the company. Additionally, larger companies benefit not only from better access to capital but also from more benefits of scale.

The market capitalization range that Ram focuses on is a point at which the company has proven its business model to some extent. They have graduated from the development stage and have achieved some sort of "escape velocity."

Mind you – there ARE companies with this level of market capitalization that are just pure speculation. You can see any number of meme stocks to see this is true.

Ram (and HX Research) are focused on real businesses with actual revenue and cash flow.

When those get to this level of size, they are in a position of sufficient scale and access to capital to take advantage.

On the other hand, though, they are not TOO big to be able to make significant returns.

The companies that comprise "The Magnificent Seven" are all spectacular businesses. They have substantial competitive moats, great balance sheets, and "flywheels" of economies of scale unlike anything ever seen.

It will be difficult for companies with $1 trillion market capitalizations to go to $10 trillion market capitalizations. To put that in perspective, a $10 trillion market cap would make a company worth 20% of the US stock market.

Do you focus on a particular market capitalization range in your long-term investing?  Tell us more in the comments section online (scroll to the bottom of the post).

It is much easier to believe a company is going from a $20 billion market cap to a $200 billion market cap.

As a result, the “sweet spot” of this market capitalization range is that you have “de-risked” the company and strategy enough to take away some of the downside. The company also has enough scale and capital that it has a real shot to capture the growth.

Finally, the math behind the market capitalization growth still works in your favor.

Now, identifying companies in this market cap range should be only ONE of your criteria when looking for big return ideas. Ultimately, you must find great businesses with significant opportunities and management that execute.

Choosing from this pool of market cap companies means you are fishing in the right pond for the BIG fish!