Blue-chips v Small-caps: Which are best?

Risk tolerance is key!

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"Blue-chips are safe as houses", said Bob. "Yes, but you can make more money from small-caps", said Joe. Who's right, could they both be?

The difference between blue-chips and small-caps can be investigated by looking at the interesting comparison between global giant ResMed Inc. (CHESS) (ASX: RMD) and much smaller Australian rival Somnomed Limited (ASX: SOM).

A Bit About the Companies

Both companies are involved in the production and marketing of devices aimed at aiding sleep apnea sufferers. Sleep apnea is a condition where an individual's airways get blocked during sleep and this results in a lack of oxygen reaching the brain. This can result in a generally poor sleep or death in the worst cases.

ResMed's devices are more 'active' at treating the illness during sleep, while Somnomed's are more 'passive' solutions.

Size Matters!

ResMed is the much larger of the two, with a market capitalisation of nearly $8 billion, versus the $66 million market cap of Somnomed. Somnomed last year recorded its fourth consecutive positive year, a net profit of around $600,000. ResMed booked a profit of over $330 million and has consistently grown profit for all but two of the past 10 years.

A Better Investment?

This is where things get tricky. In 2014, Somnomed has been the clear winner with a 47% return versus 0% for ResMed, over 12 months the numbers are 53% for Somnomed and 8% for ResMed, over 24 months its 90% for Somnomed and 71% for ResMed, while ResMed actually overtakes Somnomed over 36 months.

Indeed, over 10 years, ResMed has returned 12% annually, whereas Somnomed is still a long way from its 2004 IPO price.

Which is best?

Looking at the past can only help so much in this case. ResMed has history as an extremely reliable company that has been able to maintain huge margins over many years. Somnomed is just trying to seriously break into the sleep apnea market but has products that consumers are enjoying and is expanding internationally.

In this case, both Bob and Joe could be right! ResMed appears to be safe as houses based on its historical reliability, devotion to research and development, and huge margins, while there could be a huge amount of money to be made from Somnomed in the coming years if its products can gain traction.

The other point to consider is that ResMed's proven technology and multiple products should result in relatively predictable sales, while there are many unknowns with Somnomed that increases the risk of investment.

Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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