As stated many times before, I like to trade in small and micro-cap biotech stocks. My reason is that as a biologist and physiologist, and the fact that I worked my way through graduate school as a pharmacy technician, I understand the processes involved better than other sectors. I have also stated that this is a risky practice and emphasize anyone doing the same should always do their own Due Diligence.
That being said, I would like to introduce an interesting article on the risks/benefits of investing in small- and micro- cap stocks, written by James K. Glassman, executive director of the George W. Bush Institute in Dallas, Texas, published on Kiplinger.com . In it he acknowledges that one of the rules of investing is that the riskier the bet, the higher the payoff (should you win), and in the stock market, risk is typically measured by volatility. He goes on to state that it is natural to assume that if a particular group of stocks is more volatile than the market as a whole, then that group should return more than the market average. He defines small cap stocks as those with a market value of $1.5 billion or less.
Glassman uses the work of economist Rolf Banz, who in 1981, documented the propensity of riskier small-caps to outperform the overall market. However, Banz has been challenged by other economists and analysts, who argue that this propensity may simply be a transitory phenomenon. Glassman disagrees and provides compelling support for his argument that, over the long haul, the smaller the companies, the greater the returns, on average. .
Make no mistake, these stocks are very volatile and Glassman provides statistics to illustrate that fact. He also recommends instead of buying small cap stocks individually invest in a solid small- or micro-cap fund (I prefer to pick my own stocks). He also recommends you limit your exposure to micro- and small-caps to 10% of your portfolio, at most (I trade more like 25%, but that is an individual preference, as I am closer to retirement age and got a late start in the world of investing and trading).
He finally gives reasons for this small cap effect. The first is simply that little companies have more opportunity to grow. “If you choose well, you can score a ten-bagger with a company that has a market cap of $100 million, but choose poorly, you can lose all of your money.”
In explaining the second reason he references James O'Shaughnessy, author of What Works on Wall Street, who wrote that small-caps outperform "not because of market capitalization alone, but because the stocks in this category are least efficiently priced."
(I too find this to be true, but it can work in either direction, so be careful!)
This post is but a short summary of a long article, to read the article in its entirety go to: http://www.kiplinger.com/columns/openingshot/archives/micro-stocks-big-payoff.html
Happy trading!
Tuesday, June 22, 2010
Subscribe to:
Posts (Atom)
