DEFINITION of Small-Value Stock

Small-value stock describes stocks with small market capitalizations, as well as stocks that are trading at or below their book value. Finding a stock that fits both of these criteria is difficult but can be a worthwhile venture as small-value stocks generally yield high returns.

BREAKING DOWN Small-Value Stock

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.

According to the Fama and French model, small-cap stocks 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.

In addition, value stocks often have more upside potential, compared to their growth stock counterparts. Growth stocks tend to already possess high valuations, fueled by positive expectations.

Small-Value Stock v. Small-Cap Stock

Although most investors recognize the term small-cap stocks over small-value stocks, both overlap in terms of size. 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.

To calculate a company's market capitalization, multiply its current share price by the number of shares outstanding. For example, as of June 2018, Inogen Inc. (INGN), which makes lightweight portable oxygen concentrators, had 21,221,000 shares outstanding and a share price of $186.33. Therefore, its market capitalization is approximately $4 billion. Although this figure is over the $2 billion cutoff, some brokerages still consider Inogen a small-cap company.

Investing in small-cap 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.