Why Small Companies
- Higher Growth/Nimble Operations
Small companies grow from a smaller arithmetic base. It is easier to double sales of a $15 million company than sales of a $15 billion company. Small companies are often in growing industries and find it easier to change their strategy in response to market conditions. Smaller companies are often run by their founders or a small group of managers who are more motivated to increase shareholder value.
- Greater universe of opportunities
The 80-20 rule of investing: 80% of Wall Street research is focused on under 20% of publicly traded companies, those with market capitalizations over $1.5B. This leaves a large number of companies with little analyst coverage. With few investment managers performing in-depth research on these smaller companies and the rest relying on conventional research, an astounding number of smaller companies get overlooked. Focusing on this larger number of undiscovered companies increases the odds of uncovering hidden value.
- Inefficient market
Because few, if any, brokerage firms cover small companies, there is a greater possibility of market inefficiencies. A liquidity problem exists because most small companies have relatively few shares that trade on a daily basis. This liquidity problem prevents many large institutions from investing in these companies. This reduces the number of buyers for the stock and can cause the stock price to be unjustifiably low. Conversely, when a large buyer tries to buy an illiquid stock, the price can go up dramatically. A small company that grows and performs well will draw more attention, increasing trading volume and driving up valuation.
