Small Firm Effect

AAA

DEFINITION of 'Small Firm Effect'

A theory that holds that smaller firms, or those companies with a small market capitalization, outperform larger companies. This market anomaly is a factor used to explain superior returns in the Three Factor Model, created by Gene Fama and Kenneth French - the three factors being the market return, companies with high book-to-market values, and small stock capitalization.

INVESTOPEDIA EXPLAINS 'Small Firm Effect'

The theory holds that smaller companies have a greater amount of growth opportunities than larger companies. Small cap companies also tend to have a more volatile business environment, and the correction of problems - such as the correction of a funding deficiency - can lead to a large price appreciation. Finally, small cap stocks tend to have lower stock prices, and these lower prices mean that price appreciations tend to be larger than those found among large cap stocks.

RELATED TERMS
  1. Fama And French Three Factor Model

    A factor model that expands on the capital asset pricing model ...
  2. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  3. Return

    The gain or loss of a security in a particular period. The return ...
  4. Book-To-Market Ratio

    A ratio used to find the value of a company by comparing the ...
  5. Market Capitalization

    The total dollar market value of all of a company's outstanding ...
  6. Efficient Market Hypothesis - EMH

    An investment theory that states it is impossible to "beat the ...
RELATED FAQS
  1. Does the massive size of Berkshire Hathaway reduce its future returns?

    Berkshire Hathaway ranks among the most valuable companies in the United States, alongside such names as Google, Microsoft ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Seven Market Anomalies Investors Should Know

    Though they're unpredictable and heavily contested, market anomalies can often work in an investor's favor.
  2. Markets

    Understanding Small- And Big-Cap Stocks

    If you don't realize how big small-cap stocks can be, you'll miss some good investment opportunities.
  3. Insurance

    Market Capitalization Defined

    Find out the differences between mega-, large-, mid- and small-cap stocks and how each suits different investing styles.
  4. Markets

    An Introduction To Small Cap Stocks

    When it comes to a company's size, bigger isn't always better for investors. Find out more here.
  5. Economics

    Understanding Perpetuity

    Perpetuity means without end. In finance, a perpetuity is a flow of money that will be received on a regular basis without a specified ending date.
  6. Fundamental Analysis

    What is a Null Hypothesis?

    In statistics, a null hypothesis is assumed true until proven otherwise.
  7. Investing

    What's a Small Cap Stock?

    The “cap” in small cap stocks refers to a company’s capitalization as determined by the total market value of its publicly traded shares. Small cap stocks are generally defined as the stock of ...
  8. Investing

    Are These 2015's Most-Promising Small-Cap Stocks?

    At least one of these small-caps should spike in 2015.
  9. Mutual Funds & ETFs

    Why This Small-Cap Utilities ETF is Worth a Look

    PowerShares S&P SmallCap Utilities ETF (PSCU) has been a winner and it’s likely to remain that way barring a broad market crash.
  10. Chart Advisor

    Trade Strong U.S. Small-Caps with this Bargain ETF

    While most investors focus on the Swiss franc, quantitative easing or other global economic indicators, small-cap stocks have been outperforming.

You May Also Like

Hot Definitions
  1. Asset Class

    A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same ...
  2. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  3. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  4. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  5. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  6. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
Trading Center