size premium
Size Premium is the extra return investors expect for holding shares in small companies instead of large, well established ones, as payment for the added risk.
In plain English
Ngozi's uncle in Lagos likes to remind her that he bought shares in a small cement company back when it was still fighting for shelf space against the big players, long before it became a household name on the exchange.
He tells her the share barely moved for two years, and there were nights he wondered if he had made a foolish choice, but when the company finally broke through, his money grew far faster than it would have if he had put it in one of the giant, already established firms on the same exchange.
That gap between what he earned and what he would have earned from a big, safe company is the size premium at work. Small companies are riskier. They can run out of cash faster, they get less attention from big investors, and their shares do not trade as easily when you want to sell. Because of that extra risk, investors demand a higher expected return to bother holding them at all.
In the United Kingdom, this shows up when someone chooses a small cap fund tracking companies on the AIM market instead of a fund holding only FTSE 100 giants like Unilever or BP. The small cap fund can swing wildly in bad years, but over long stretches it has historically rewarded patient investors with returns the blue chip fund could not match.
A Nigerian in London sending money home to invest often faces this choice without knowing its name. Put the money into a small, promising Nigerian company with room to grow, or a large, stable one that barely moves. The size premium is the reason the small company, if it survives and grows, can pay so much more for the wait.
Suppose a small Nigerian agro processing company's shares return 22 percent a year on average, while a large, established bank's shares return 14 percent a year. That extra 8 percent is roughly the size premium investors are earning for taking on the smaller company's risk.
Questions people ask
Is the size premium guaranteed every time you buy a small company's shares?
No. It is an average tendency seen over long periods across many small companies, not a promise for any single stock. Plenty of small companies shrink or fail, and you get no premium at all, only losses.
Why do small companies offer higher expected returns in the first place?
They tend to have less cash cushion, less access to credit, thinner trading volumes, and less analyst attention, so investors want extra compensation for the added uncertainty of holding them.
How can an ordinary Nigerian investor try to capture the size premium safely?
Spreading money across several small and mid sized companies rather than betting everything on one, and being ready to hold for years rather than months, is the usual sensible approach.
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