What Is a Small-Value Stock?
A small-value stock describes stocks that intersect in terms of the investment capital size that the market has given to it and its current price compared to a valuation model. A simplified example might include 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.
- Small-value 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 used, or how detailed the valuation model, a true small-value stock may be a unicorn in the investing world—rare and seemingly mythical.
- Stocks trading under their model value that also have low market capitalization might have excellent opportunities for growth, but may have greater risk of failure over time.
Understanding a 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.
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.