Some investors have expressed surprise that so many small-cap companies continue to focus their investor relations efforts on getting the attention of institutions, rather than pitching their wares directly to the public. While it is certainly true that many of these companies will fail to generate the kind of attention among Wall Street analysts that companies listed on the Dow Jones Industrial Average (DJIA) enjoy, it is also true that generating coverage by a single big-name analyst is likely going to be more worthwhile than capturing the attention of 1,000 individual investors.

Institutional Attitudes
From the other end of the spectrum, Wall Street's limited attention to small caps is not surprising. The large institutional investors run Wall Street research, which caters to the needs of institutional shareholders.

The link is an obvious one in that the large banks, mutual funds, pension funds and endowments that make up the bulk of institutional investors account for the bulk of the stock market's daily trading volume and the bulk of the fees paid to Wall Street. There's no mystery here: talent and resources follow the money. This often means that small cap stocks escape the radar when it comes to Wall Street research

Another important point to consider is liquidity. Many publicly-traded stocks are caught in liquidity limbo: they have good fundamentals but not enough trading volume for large institutions to take notice. Large mutual funds trade billions of dollars. In order to buy a large enough position in a stock for the holding to have any impact at all on the overall portfolio, the big funds need to make big purchases of securities.

A single fund might need to purchase nearly every outstanding share of a small company's stock just to get enough shares to represent 5% of the fund. If the fund ever needed to sell, it would be at the mercy of buyers because the marketplace for those shares would be illiquid. Trading shares of a company listed on a major market index such as the Dow or S&P 500 is a much safer bet.

The Impact of Individuals

Individual investors have a larger impact today than ever before. First, the Internet provides the individual with the power to do his or her own research and make trades. Secondly, individuals advance their education every day thanks to the information provided in the financial press and investment-related websites.

When the SEC adopted Regulation FD (for "fair disclosure") in 2000, individual investors got more of a level playing field with their institutional counterparts. The law prohibits all publicly-traded companies, except for investment companies (other than closed-end investment companies), from disclosing information to securities market professionals, such as securities analysts or institutional investors, before disclosing the information to the public. Professional research can also be purchased.

While professional investment firms still have vast resources not commonly available to individual investors, if you have the time and energy to do your own research, you can get equal access to the data. Overall, the Internet, investor education efforts and legislative changes have combined forces to reduce the individual investor's dependency on large Wall Street brokerage firms.

DIY Research
When looking at small-cap companies, even though you won't likely be able to access or find research reports, it is important to still do your own due diligence. Thankfully, through greater access to information from increased laws and the use of the Internet, this has become easier than ever. It is important to gain a full understanding of the small cap's business, how the company makes money and its plans to grow. Also, ask yourself whether the company's revenue is sustainable and determine whether it is making money. If not, how long will it be until the company becomes profitable? Does the company have the funds to sustain these losses?

If you want to try your hand at besting the big boys and doing your own research, the tools are available to help you give it try. On the other hand, just because you can do something doesn't mean that you should. If you choose to try, be smart and use only a small portion of your assets to invest in the little gems that you uncover, and leave the rose-colored glasses at home.

The Bottom Line
Studies have shown that Burton Malkiel's "blindfolded monkey throwing darts at a newspaper's financial pages" may indeed be able to select a portfolio that would beat the experts, as demonstrated by picks from celebrity centerfolds and Wall Street Journal staff members, but just as the experts can and have been beaten, you can be beaten too. So, test your skills and enjoy the experience, but don't bet the ranch on your picks.

Related Articles
  1. Chart Advisor

    ChartAdvisor for February 5, 2016

    Weekly technical summary of the major U.S. indexes.
  2. Mutual Funds & ETFs

    The 5 Best US Small Cap Value Index Mutual Funds

    Find out which index mutual funds do the best at investing in small-cap value stocks for higher potential returns at the lowest cost.
  3. Stock Analysis

    The Top 5 Micro Cap Biotechnology Stocks for 2016 (BSTC, OSIR)

    Discover some of the most promising micro-cap biotechnology stocks that investors can consider for their 2016 investment portfolio.
  4. Mutual Funds & ETFs

    3 Eaton Vance Mutual Funds with Long Track Records (EV)

    Discover three Eaton Vance mutual funds with long track records. Review brief descriptions about each fund's management and performance.
  5. Mutual Funds & ETFs

    The Top 5 Small-Cap Core Mutual Funds for 2016

    Discover five mutual funds that specialize in investing in core small-market capitalization stocks traded on U.S. stock exchanges.
  6. Chart Advisor

    ChartAdvisor for January 29, 2016

    A weekly technical summary of the major U.S. indexes.
  7. Stock Analysis

    The Top 5 Micro Cap Telecommunication Stocks for 2016 (CLFD,LMOS)

    Identify and learn about five of the best micro-cap telecommunications stocks to consider for your diversified portfolio for 2016 and beyond.
  8. Stock Analysis

    The Top 5 Small Cap Restaurant Stocks for 2016 (BLMN,DENN)

    Learn about the market conditions that could help continue pushing restaurant stocks higher in 2016 and the five small-cap restaurants that are worth a look.
  9. Stock Analysis

    The Top 5 Restaurant Penny Stocks for 2016 (SAUC, GTIM)

    Take a look at five restaurant stocks that are trading below $5 heading into 2016. These penny stocks could produce sizable returns.
  10. Stock Analysis

    The Top 5 Small Cap Software Stocks for 2016 (MOBL,OPWR)

    Watch for bargains among small-cap software stocks by following their share price performances for signals of strength during periods of broad-market volatility.
RELATED FAQS
  1. What are the most important equity market indexes?

    The most important equity market indexes are the S&P 500, Nasdaq Composite and Russell 2000. These indexes in total provide ... Read Full Answer >>
  2. What is considered a good turnover ratio for a mutual fund?

    What is considered a good turnover ratio for a mutual fund depends on the fund's composition and structure, its stated investment ... Read Full Answer >>
  3. Is it more beneficial to invest in a blue chip stock or a penny stock?

    Penny and blue-chip are terms used to describe a stock's valuations and statures. Penny stocks are generally the stocks of ... Read Full Answer >>
  4. What is the difference between a penny stock and a small cap stock?

    A penny stock and a small-cap stock represent the shares of a company with low market capitalizations. However, there is ... Read Full Answer >>
  5. What does the Dow Jones Industrial Average measure?

    The Dow Jones Industrial Average (DJIA) is the oldest and best-known stock market index. It measures the daily price movements ... Read Full Answer >>
  6. What is the difference between the Dow Jones Industrial Average and the S&P 500

    The Dow Jones Industrial Average (DJIA) and the S&P 500 are both widely followed American stock market indexes. The major ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center