“Small-cap stocks can have significant growth potential and often remain undervalued by the market,” says Asher Rogovy, chief investment officer at Magnifina, a portfolio management firm.
“Small cap stocks often have significant growth potential, yet remain undervalued by the market. It’s more likely that a small cap stock will double or triple than a large cap. Some scholars would say that this phenomenon can be explained simply because small cap stocks tend to be riskier. However, I view it as a disproof of the efficient markets hypothesis.
One reason for this is liquidity. Huge asset managers that handle enormous pension funds simply can’t allocate small cap stocks to their model portfolios. To do so could distort the price of a small stock as demand would significantly outweigh supply. Even if they recognize the investment value of a small cap stock, these managers must avoid it. They also are somewhat risk averse, and tend to look for safer, large cap stocks while sacrificing performance.
Another reason that small cap stocks are undervalued is the availability of news and research. Because small caps are ineligible for some portfolios, they are covered by fewer analysts and reporters. Less reporting means less demand from investors, which means a lower price. As the company grows into a larger class, more investors will find it thus increasing its valuation.”
Altered with permission