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What I Have Learned about Small Company Stock Investing

8/18/2022

Investment club expert Russell Malley shares lessons from three decades of investing in individual companies.

Editors’ Note: Since 2020, Russell Malley has served as an Analyst for the SmallCap Informer. Widely-known in the BetterInvesting, ICLUBcentral, and investment club communities, Russell brings his decades of investing knowledge to the SmallCap Informer as well. For this special anniversary issue, we asked Russell to share some of his insights about small company with subscribers.

I have served as an analyst for the SmallCap Informer for just shy of two years, but I have been a subscriber since the beginning and investing in stocks for more than 30 years.

Along the way, I have gained a fair bit of insight into analyzing and selecting smaller companies for a diversified portfolio of stocks, suitable for an investment club or an individual investor.

Here are six observations based on my experiences that investors should keep in mind when considering smaller companies for their portfolios:

1.    Expect to work harder finding and analyzing ideas for purchase.
2.    Expect to rely more on your own judgement.
3.    Expect a bumpier ride.
4.    Know your risk tolerance.
5.    Practice increasing your patience.
6.    Expect to make mistakes.

The first two points have some common causes. You will need probably need to work harder to discover candidate stocks and rely more on your personal judgment when investing in small and medium sized companies, largely because they have fewer analysts covering them. Free resources from a library, such as Value Line and Morningstar, often give only basic company statistics and a description of the business, if they even follow the company in the first place. When analyst estimates for sales and/or EPS growth are provided, a little digging reveals the total number of analysts included in the “consensus” is between one and five—adding new context to the plural “estimates.”

Since estimates for future sales and EPS growth may be limited, you will need to work harder (or pay more) to get opinions to help make or check your projections of future growth. As a SmallCap Informer subscriber, you get help from us finding and analyzing small and medium sized companies.

If you use BetterInvesting’s Online SSG tools, the Research tab can also help. Even with these resources, you will need to rely on your own judgement more when investing in small and medium sized companies.

You should certainly expect a bumpier ride when investing in small and medium-sized companies with their higher volatility. Fewer analysts that cover these companies and lower trading volumes contribute to this volatility.

The greater unpredictability of these companies makes it more important to heed the fourth point: Know and understand your personal level of risk tolerance. Many assessments of investment risk tolerance are available with a quick internet search. (I prefer to use one of the many associated with an institution of higher learning.)

Be aware, though, that these assessments are estimates. You might also notice, as I did, that   final scores may change depending on your mood when you took the quiz! Changes in your financial situation, length of time until retirement, and your general investment and life outlook may cause your risk tolerance to shift over the years. Make time to give yourself a check up on your risk tolerance every so often. And remember, while these quizzes may be helpful, the acid test of your risk tolerance is the ability to sleep comfortably with the investments you have made.

Patience is good for all investors but especially for those investing in smaller companies. Positive operating news for small and medium sized stocks often takes more time to be reflected in their stock prices. With less analyst coverage and reduced awareness of and interest in small and medium sized companies among the general investing population, it takes more time for positive news to be reflected in prices, and bad news be forgiven.

My personal experience indicates that patience may be one of the harder traits to develop. Over the years, I have sold companies only to see them rebound and earn substantial gains. I have since learned to analyze the current situation carefully before making a sell decision as a check on the impact of fear and emotion.

This brings me to the last item on my list: expect to make mistakes. We all make mistakes, even the most successful investors. The important thing is to learn from your mistakes.

One of my biggest challenges when I was teaching was getting students to respond to questions posed during class. At the beginning of the term, I tried to encourage responses by emphasizing the goal was for them to learn the subject matter. When they answer questions, they will learn something, no matter if their answer was correct or not. 

Accept you will make mistakes. Just be sure to learn from them.

  • RUSSELL MALLEY

Read the complete commentary and profiles of our two recommended small company stocks in the September 2022 issue of the SmallCap Informer stock newsletter.

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