What’s The Relationship Between Liquidity and Small Cap Value Stocks?

Generally speaking, small cap value stocks aren’t the most glamorous stock picks. They’re not brand names that you’re going to brag to your friends about at cocktail parties. The term “small cap” derives from having a comparatively small market capitalization, meaning that they are companies with fewer shares on the market than major corporations like Apple. The exact limit that separates small cap stocks from mid-cap and/or large cap stocks varies among different brokerage firms. However, liquidity can be an issue with small cap stocks.

Why Don’t They Sell?

As Shailesh Kumar at Value Stock Guide explains, there are many good reasons to buy small cap stocks, but if you’re looking for liquidity, assets that are easy to sell, small cap stocks may not be your best choice. The good news is that they are considered an “easy buy” by many solo investors because institutional investors, such as mutual fund managers, have Securities And Exchange Commission (SEC) restrictions that prevent them from buying too many shares (controlling interest) in a small company. The bad news is that, in terms of liquidity, small caps stocks don’t generally garner enough attention in the market for investors to be able to sell them easily.

Wall Street Plays Favorites

Generally speaking, the stock market trends towards favoring growth stocks in companies that people are familiar with. Although, small cap stocks have historically always out performed large cap stocks by a 2% margin, they’re often considered “orphaned stocks” that don’t make financial news because of their smaller size and liquidity problems. Simply put, small cap stocks are the one of the best secrets in the stock market because no one really talks about them. On the other hand, the fact that they aren’t widely discussed is what makes them market beating returns for investors who are willing to do some research.

The “Tick Size” Bill

In May of 2013, the Spread Pricing Liquidity Act of 2013 (Tick Size Bill) was introduced in the House of Representatives. If this bill becomes a law, it would increase the exposure of small cap stocks to investors and allow for smaller companies to have great access to investment funding. The aim of the bill is to increase the tick size, the increment that a stock price moves by, so that small cap stocks will become more liquidable. In essence, the bill could potentially remove one of the biggest disadvantages of small cap stocks.

Investment strategy is an art form and every investor is an artist with his or her own unique approach. Small cap stocks are considered value stocks because investors can often buy them at a lower price and see better returns than they can with hot growth stocks. On the other hand, if you need to sell off assets to cover losses in your portfolio, small cap stocks can be like trying to sell a house that needs a lot of work. If the Tick Size Bill passes then this situation may change, but as of this writing, small cap stocks are better suited for buy and hold investors.

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