Equity Investment Universe

It's estimated that there are over 190 million companies in the world. That's a lot! While most of these companies aren't publicly traded, in the United States alone there are roughly 19,000 listed companies. How might you describe the potential equity investment universe?

Clearly, no. With hundreds of thousands of public companies, the universe isn't small.

That's not it. The universe of public companies isn't medium sized; there are over 190 million companies in the world.

First, you can segment the equity universe by size and style. If you're familiar with investment lingo, you've probably heard the terms "large cap," "mid cap," and "small cap." These terms refer to segmentation by size. When it comes to style, companies are classified as value or growth, or a combination of value and growth, by analyzing price-to-book ratios, price-to-earnings ratios, earnings growth, dividend yield, and book value growth. For the largest companies with various product lines, this can be a challenge sometimes. Why might a large company with various product lines present a challenge?

Not quite. Even for the largest companies, the balance sheet can usually be categorized.

That's not it. The company's growth rate can be calculated from historical values and future management estimates.

This segmentation by size and style can help analysts in many ways. Not only does this segmentation help managers construct equity portfolios that reflect proper risk, return, and income factors, it also results in a wide variety of companies. What's another way to view this multiple-company segmentation benefit?

This natural shift over time can also help managers adjust holdings over time for more accurate exposure, but this shifting over time can also be a disadvantage. Not only can the categories change over time, but there are also no set rules defining value versus growth or defining specific company sizes. What can this lack of rules lead to?

That's not it. Multiple companies don't necessarily provide a core return focus.

Not quite. Liquidity isn't a reason for multiple-company holdings. Also, these are companies that are publicly traded.

That's not it. Highly risky portfolios won't result from different investor classifications as long as investors apply those classifications universally.

No. Concentrated portfolios aren't a product of investors using their own classifications.

Clearly, yes! With 190 million companies in the world, there are a lot of opportunities. That's why it's important to understand how to properly analyze and separate the equity universe. There are several approaches to do this.

Right! For the largest companies, some divisions can fall into growth and some can fall into value. In fact, some companies will tend to shift back and forth over time as new business lines switch from value to growth or growth to value. This is why many analysts use a matrix of nine boxes that categorizes companies by both style (value, core, and growth) and size (small, mid, large).

That's right! By segmenting companies into various sizes and styles, managers are forced to diversify into different industries and sectors. That leads to better diversification in the portfolio. Additionally, managers can also use segmentation by size and style to construct portfolios that beat a set benchmark, such as a mid-cap value. As a final benefit, segmentation by size and style allows managers and investors to follow a company's life cycle from the initial small-cap growth stages to the (hopefully) large-cap growth or value stage.

That's it! Since there are no set rules for size and styles, there can be confusion on a company's specific size and style categories. That's a disadvantage of using size and style segmentation.

To summarize: [[summary]]

Small

Medium

Enormous

The balance sheet is too difficult to categorize

The company's growth rate is difficult to understand

Different business segments can fall into different classifications

Diversification

Core return focus

Proper liquidity segmentation

Highly risky portfolios

Concentrated portfolios

Different classifications amongst different investors

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