DEFINITION of 'Neglected Firm Effect'

A theory that explains the tendency for certain lesser-known companies to outperform better-known companies. The neglected firm effect suggests that the lesser-known companies are able to generate higher returns on their stock shares, because they are less likely to be analyzed and scrutinized by market analysts. The smaller firms might also exhibit better performance, because of the higher risk/higher reward potential of small, lesser-known stocks, with a higher relative growth percentage.

BREAKING DOWN 'Neglected Firm Effect'

Smaller firms are not subject to the same scrutiny and analysis as the larger companies, such as blue-chip firms. Analysts have a vast amount of information at their disposal, on which to form opinions and make recommendations. The information regarding the smaller firms may at times be limited to those filings that are required by law. As such, these firms are "neglected" by analysts, because there simply is not much information to scrutinize or evaluate.

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