Small-Value Stock

What Is Small-Value Stock?

A small-value stock, or small-cap value stock, describes a class of shares that intersect in terms of their market capitalization and its valuation style. In particular, they are small-cap stocks that are also categorized as value stocks.

Key Takeaways

  • According to Fama and French's three-factor model, small-value stocks possess two important qualities: small-cap size and value.
  • Small-cap stock implies a company that has raised less than two billion in market capitalization and is trading low relative to a given valuation model.
  • Depending on how narrow the definition is used, or how detailed the valuation model is, a true small-value stock may be a unicorn in the investing world—rare and seemingly mythical.
  • Stocks deemed to be undervalued that also have small market capitalization might have excellent opportunities for growth, but may also have a greater risk of failure over time.

Understanding Small-Value Stock

A simplified example of a small-value stock might be a stock trading below its book value with a market capitalization below one billion dollars. Finding a stock that fits both of these criteria is difficult but may be a worthwhile venture as small-value stocks are generally considered to yield high returns.

According to Fama and French's three-factor model, small-value stocks possess two important qualities: size and value. The Fama and French model expands on the capital asset pricing model (CAPM) by adding size and value factors to the CAPM’s market risk.

The Fama and French model suggests that small-cap stocks generally tend to outperform the markets, over and above large-cap stocks, on a regular basis. This is due to the fact that in general small stocks have a greater opportunity to grow. They are more under-the-radar (not as well-covered by analysts) and nimble to develop and take advantage of new technologies. A small-value stock, however, would not be classified as a growth stock.

In this case, value stocks will often have upside potential based on fundamentals, compared to their growth stock counterparts that instead may have a lot of potential but may not have solid balance sheets or even profitability. Growth stocks tend to already possess high valuations, fueled by positive expectations.

While there is some debate over the cutoff for small versus micro- or mid-cap stocks, in general, small-cap stocks are between $300 million and $2 billion in size.

Small-Value Stock Vs. Small-Cap (Growth) Stock

Although most investors will recognize small-cap stocks as growth stocks in general, small-cap value stocks deviate from this expectation.

Investing in small-cap growth stocks offers the opportunity to beat institutional investors since most mutual funds have restrictions that limit them from buying large portions of any one company's outstanding shares. Since small-cap stocks have a smaller float (shares available for trading) than large-cap stocks, it is difficult for mutual funds to purchase a percentage of shares that does not exceed restrictions and inflate the share price.

Many small-cap value funds are popular among investors. Instead of individually selecting securities, these investors can buy shares in a fund that a manager has pre-selected. One example is the T. Rowe Price QM U.S. Small-Cap Growth Equity Fund (PRDSX).

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