Your opinion is consistent with the fundamental idea that capital
markets are efficient. This means "...that security prices accurately
reflect available information and respond rapidly to new information
as soon as it becomes available.... It doesn't say that there are no
taxes or cost; it doesn't say that there aren't some clever people and
some stupid ones. It merely implies that competition in capital
markets is very tough -- there are no money machines, and security
prices reflect the true underlying values of assets," (page 916).
However, there is evidence suggesting that "... you can apparently
generate superior average returns by investing in small companies,"
(page 920). Possibly, "the stock market is inefficient and
consistently under prices stocks of small firms," (page 920).
Source: Principles of Corporate Finance, fourth edition, Brealey &
Myers, McGraw-Hill Inc., 1991
As you rightly note, "... pension funds, hedge funds, and other
institutional investors carry much more weight in the market and
individual buyers...." However, they are only interested in companies
with large market capitalizations because they have to trade large
blocks of shares. Trading large blocks of shares in thinly traded
companies is apt to move the stock price against the seller at best.
In times of market turmoil, it may not even be possible to sell a
large amount of a small company. In addition, because institutions
are the predominant force in the marketplace, investment banks are
providing much less research on smaller companies. As a result, "...
small companies are trading at a steep discount to larger ones. Even
after a sharp rise in small-cap stocks over the past two years, the
small and midsize companies making up the Russell 2000 index are still
trading at just 2.16 times their book value. By contrast, the large
companies in the Dow Jones industrial average are trading at 3.44
times their book value. Until 1998, there was hardly any gap."
Source: "A Little Privacy, Please" by Emily Thornton, BusinessWeek,
May 24, 2004, pages 74-75 (also available online at
http://www.businessweek.com/@@*cPFpIQQmFdhDg0A/magazine/content/04_21/b3884102_mz020.htm
under the title "Why Small Companies Want A Little Privacy")
Although small businesses are struggling in the stock market,
private-equity firms are increasingly interested in taking them
private. Increased costs imposed upon publicly traded companies by
Sarbanes-Oxley also adversely affect smaller companies
disproportionately, making going private more attractive.
Therefore, while your statement is likely to be accurate for large
companies, opportunities potentially exist for small investors
investing in small companies. A small investor can purchase shares at
an attractive price hoping that something will cause the company's
market capitalization to grow to the point where institutional
investors become interested. Alternatively, a small investor may have
the opportunity to have his investment taken private at an attractive
price. Finally, the gap that has opened up since 1998 in valuation
between large-capitalization stocks and small-capitalization stocks is
unlikely to remain forever. Sooner or later, something will probably
occur to close it, resulting in either an increase in value of
small-cap stocks or a decrease in value of large-cap stocks. Either
way, your friend would benefit relative to owning large-cap stocks.
While opportunities in the market exist for small investors, it is
important to remember that it is never easy to make money trading
stocks and there are always risks. I hope you have found this
perspective interesting and useful.
Sincerely,
Wonko |
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