What are small value stocks?
Value stocks have different categories, and one of those is a small value stock. Other people refer to it as a small-cap value stock. These are shares with market capitalization and variation styles that intersect. If we are to name an example, we can include a stock that trades lower than its book value and a market capitalization lower than one billion dollars. It’s not an easy task to find a stock that has these two criteria. However, many people can’t deny that small value stocks have a reputation for bringing high yield returns.
The Fama and French’s three-factor model
Fama and French’s three-factor model states that small value stocks have two essential qualities. With all the things we have mentioned earlier, you may already know what they are: size and value. This model expands on the CAPM or capital asset pricing model through additional sizes and value factors to its market risk. It tells us that small-cap stocks will most likely outperform the markets. They will be over and above large-cap stocks regularly. But why? Generally, small stocks have massive chances for growth. They do not always get the attention of analysts. Hence, they do not get enough coverages. They are quick to develop and benefit from new technologies.
Small value stocks are not growth stocks.
Even though we are mentioning all of these, we do not consider them as growth stocks. So, this is more like an advantage for them if we are looking from a fundamental perspective, unlike growth stocks. Growth stocks may look promising, but in reality, they may not be profitable or have solid balance sheets. Growth stocks somehow have high valuations beforehand that come with positive expectations.
What sets small value stocks apart from small-cap growth stocks?
Small-cap stocks are constantly being confused with growth stocks and vice versa. However, these two are considerably different. Investors who have small-cap growth stock investments have chances to beat those involved with institutional ones. But why? Mutual funds come with restrictions. Hence, institutional investors can only buy limited portions of the company’s outstanding shares. On the other hand, small-cap stocks have a more petite float against large-cap stocks. For your information, float refers to shares that are available for trading. Mutual funds find it hard to buy a share percentage that goes beyond the restrictions. They can never inflate the share price. These are some reasons why many investors prefer small-cap value funds. They can directly buy fund shares that the manager already selected beforehand instead of selecting securities by themselves.
What have we learned so far about small-value stocks?
Fama and French’s three-factor model tells us that small value stocks have two essential qualities. These are small-cap size and their value. Small-cap stocks refer to companies with less than two billion market capitalization and trading at lower prices compared to the given valuation model. The valuation model details and the definition used are some factors that affect small value stocks. They are pretty rare and unusual in the investment world. It is almost impossible for analysts to miss out on great stocks or companies. Undervalued stocks with smaller market caps tend to have promising growth opportunities. However, they also come with risks of failure in the long run.