Stingy Investor Search - Contact - Subscribe - Login
  Home | Articles | Links | SNW
Small, illiquid stocks offer best value

Far too many investors look for big, popular, and liquid stocks. They fawn over large firms with excellent prospects that are easy to trade. Problem is, loved stocks often come with big price tags and that can to lead to disappointing returns.

On the other hand investors who take the opposite tack and favour small value stocks that don't trade frequently tend to do quite well. But they swap comfort for profits as they scour the back alleys of the market where many fear to tread.

While the return potential of small value stocks is well known, the benefits of low liquidity may be less obvious. That's why I was pleased to read a study on the topic by Roger Ibbotson, and others, in the latest Financial Analysts Journal, which dissects mutual funds.

They examined the holdings of U.S. equity mutual funds, offered for sale to U.S. residents, from February, 1995, to December, 2009. Each fund was classified into different groups based on the size of the stocks held (as measured by market capitalization), where they stood on the value-growth spectrum (based on a 10-factor model from Morningstar), and their liquidity. Liquidity was calculated by taking a stock's average volume over the last year divided by its shares outstanding.

True to form, value funds fared better than growth funds over the period. They outperformed by an average of 80 basis points annually. Similarly, funds with small stocks beat those holding large stocks to the tune of 189 basis points annually. Combine both factors and you'll find small-cap value funds beating large-cap growth funds by an average of 323 basis points a year.

Given the record, it may be surprising to learn that there were 238 small-cap value funds on offer in the United States when the study ended and 1,048 large-cap growth funds. Hope springs eternal for growth investors.

When you add liquidity into the mix the differences become even more dramatic. But funds holding less liquid stocks fared better across the board. It didn't matter whether they were value funds or growth funds. The same goes for funds with large or small stocks. Mind you, the effect was most pronounced in the small-cap arena.

For instance, value funds that held the least liquid 20 per cent of stocks outperformed value funds with the most liquid stocks by 228 basis points. Similarly, growth funds with the least liquid stocks outperformed those with the most liquid stocks by 225 basis points.

The results grow when you combine all three factors. Funds following the least-liquid small value stocks beat those with the most-liquid large growth stocks by a whopping 499 basis points on average each year.

But just how illiquid are the low liquidity stocks? After all, some stocks trade only a few times a day but many funds would be hard pressed to buy a significant amount of them. In the study the least liquid 20 per cent of stocks held by the funds had average annual turnovers of 110 per cent. Theoretically all of their shares traded hands a little more than once a year. On the other hand, the high liquidity 20 per cent group had annual turnovers of 573 per cent.

That comes as good news to small investors because it should be easy to put modest amounts of money to work in such stocks. It isn't necessary to stick to companies that basically trade by appointment to take advantage of the low-liquidity effect.

However, there remains an inherent problem with small value funds. They can still only put a limited amount of money to work without growing out of their niche. Once they get too big, perhaps powered by good performance, they're forced to move into larger names. As a result, it remains an area where smart small investors have an advantage.

As much as I'd like to recommend small illiquid value stocks to a wide audience, they require some dedication and experience. But it's a very worthwhile area for those with the interest.

First published in the Globe and Mail, December 16 2012.

Globe & Mail Articles

 Dividend All-Stars for 2024
 250 Megastars for 2024
 Extreme yields
 The easy way
 Smaller stable dividend
 250 Megastars for 2023
 Champagne portfolio
 Screaming Value
 Blended momentum
 Dividend monster
 Frugal dividend
 Stable dividend
 Speads and recessions
 TSX 60 for value investors
 Looking at 10-year returns
 Watching for a bottom
 Oh, bother!
 Indexing advice
 Media-shy stocks
 Curse of size
 Market uncertainty
 Be even lazier
 Scary beats safe
 Small, illiquid, value
 Use the numbers
 What value is good value?
 Sculpt for value
 Value vs CAPE
 Graham Rules
 CAPE vs PeakE
 Top value ratio
 Low Beta
 Value and dividends
 Walter Schloss
 Try unloved AIG
 Why I'm a value investor
 New world of ETFs
 Low P/Es possible
 10 yielders
 Be happier
 Dividend Downside
 Shiller's P/E
 Copycat investing
 Cashing in on class
 Index roulette
 Theory collides
 Diving too deep
 3 retirement villains
 Scourge of inflation
 Economic omens
 Analyst Expectations
 Value stock scarcity
 It's all in the index
 How to pick good funds
 Low Beta Wins
 Hunt for dividend stocks
 Think garage sale

MoneySaver Articles
 2 Graham Stocks for 2018
 2 Stingy Stocks for 2017
 2 Graham Stocks for 2017
 3 Stingy Stocks for 2016
 5 Graham Stocks for 2016
 3 Stingy Stocks for 2015
 3 Graham Stocks for 2015
 3 Stingy Stocks for 2014
 4 Graham Stocks for 2014
 8 Stingy Stocks for 2013
 6 Graham Stocks for 2013
 9 Stingy Stocks for 2012
 8 Graham Stocks for 2012
 Simple Way 2011
 5 Stingy Stocks for 2011
 7 Graham Stocks for 2011
 Simple Way 2010
 5 Stingy Stocks for 2010
 8 Graham Stocks for 2010
 Simple Way 2009
 Timing Temptation
 19 Stingy Stocks for 2009
 4 Graham Stocks for 2009
 Simple Way 2008
 Active at Passive Prices
 Unbundling ETFs 2008
 5 Stingy Stocks for 2008
 5 Graham Stocks for 2008
 Is your index too active?
 Graham's Simple Way
 Canadian Graham Stocks
 5 Stingy Stocks for 2007
 8 Graham Stocks for 2007
 Top SPPs
 The Simple Way
 A hole in your IPO?
 Monkey Business
 8 Stingy Stocks for 2006
 Graham Stock Gainers
 Blue-Chip Blues
 Are Dividends Safe?
 SPPs for 2005
 Graham's Simplest Way
 Selling Graham Stocks
 RRSP Money Market Funds
 Stingy Stocks for 2005
 High Performance Graham
 Intelligent Indexing
 Unbundling Canadian ETFs
 A history of yield
 A Dynamic Duo
 Canadian Graham Stock
 Dividends at Risk
 Thrifty Value Stocks
 Stocks in Short Supply
 The New Dividend
 Hunting Goodwill
 SPPs for 2003
 RRSP: don't panic
 Desirable Dividends
 Stingy Selections 2003
 10 Graham Picks
 Growth Eh?
 Timing Disaster
 Dangerous Diversification
 The Coffee Can Portfolio
 Down with the dogs
 Stingy Selections
 Frugal Funds
 Graham Revisited
 Just Spend It
 Ticker Temptation
 Stock Mortality
 Focus on Fees
 SPPs for the Long Term
 Seeking Solid Stocks
 Relative Strength
 The VR Approach
 The Irrational Investor
 Value Investing

Old MS Articles
 Cdn Top 200 2018
 Cdn Top 200 2017
 Cdn Top 200 2016
 Cdn Top 200 2015
 Cdn Top 200 2014
 Cdn Top 200 2013
 Cdn Top 200 2012
 Cdn Top 200 2011
 Cdn Top 200 2010
 Cdn Top 200 2009
 Cdn Top 200 2008
 Cdn Top 200 2007
 Cdn Top 200 2006
 Cdn Top 200 2005
 US Top 500 2018
 US Top 500 2017
 US Top 500 2016
 US Top 500 2015
 US Top 500 2014
 US Top 500 2013
 US Top 500 2012
 US Top 500 2011
 US Top 500 2010
 US Top 500 2009
 US Top 500 2008
 US Top 500 2007
 US Top 1000 2006
 Dividends 100 2017
 Dividends 100 2016
 Retirement 100 2015
 Retirement 100 2014
 Retirement 100 2013
 Retirement 100 2012
 Retirement 100 2011
 Retirement 100 2010
 Income 100 2009
 Income 100 2008
 Income 100 2007
 Top Trusts 2006
 Top Trusts 2005
 Hot Potato
 Buffett Buys
 Stocks that pay
 Value in the S&P500
 Where to invest $100k
 Where to invest $10k
 Summer Simple Way
 A crystal ball for stocks?
 Cheap & safe
 Risky business
 Dividend investing
 Value investing
 Momentum investing
 Low P/E P/B
 Dividend growers
 Graham's prescription
 The case for optimism
 Wicked investments
 Simply spectacular
 Small stocks, big profits
 Value that sizzles
 So simple it works
 No assembly required
 Investing by the book
 Invest like the masters
 A simple way to get rich
 Stocks for cannibals
 Car bites dogs
 So easy, so profitable
 Dogs of the Dow
 Money for nothing
 Yield of dreams
 Return of the master

Advisor's Edge Articles
 Passive Rebundling
 Doing the math

Flip Books

About Us | Legal | Contact Us
Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...