The Small Investor and the Competition for Information
We're looking for the prospect of an accelerating rate of positive change. That means we're naturally drawn to management changes, turnarounds, or, more generally, to situations in which changes in the macroeconomic, competitive or regulatory landscape require a company to remake what it does or how it does it. That strategy is particularly tailored to small caps. Simpler business models are easier to analyze and cross-check, while at the same time change happens faster in small companies, making for more investable inflection points. One or two people can also make a big difference, quickly.
Mariko Gordon, Daruma Capital Management
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In Chapter five of The Big Secret for the Small Investor, Joel Greenblatt framing small-cap stocks and special situations around a single central thesis: To beat Wall Street, the individual investor must "change the game" and play where big institutional money cannot go.
While Greenblatt devoted an entire classic book (You Can Be a Stock Market Genius) to corporate restructurings, in The Big Secret, he contextualizes both small caps and special situations as primary structural advantages for the small investor.
1. Small-Cap Stocks: The Institutional Blind Spot
Greenblatt emphasizes that large mutual funds, hedge funds, and pension funds manage tens or hundreds of billions of dollars. Because of their massive size and regulatory constraints, they face strict limits:
The Liquidity Trap: A $10 billion fund cannot take a meaningful position in a $200 million small-cap company without moving the stock price or owning an uncomfortably large percentage of the business.
Analyst Neglect: Because Wall Street brokerage firms make their money selling ideas to large institutions, analysts rarely cover small-cap and micro-cap stocks.
Wilder Inefficiencies: Less analyst coverage and lower trading volume mean small-cap prices are far more susceptible to emotional swings, neglect, and mispricing. This creates wider margins of safety and much larger discount-to-value opportunities for individual investors.
Systematic Edge: Applying value-based screens (like fundamental weighting or his Magic Formula framework) yields even higher relative outperformance in small-cap universes than in large-cap universes simply because the mispricings are so much more severe.
2. Special Situations: Profiting from Forced Selling
Greenblatt highlights special situations—such as spinoffs, liquidations, restructurings, bankruptcies, asset sales, and rights offerings—as another area where big institutions consistently hand bargains to small investors:
Institutional Mandates & Forced Selling: When a large parent company spins off a small subsidiary, institutional managers frequently sell the spun-off shares immediately regardless of valuation. They do this because the spin-off is too small to affect their portfolio, falls outside their fund's mandate (e.g., non-dividend paying, different market cap sector), or is not included in their benchmark index.
Price Distortions: This indiscriminate, mechanical dumping creates severe price declines that have nothing to do with the actual underlying business quality or economic prospects of the spun-off company.
Focusing on "Obvious Bargains": Greenblatt advises small investors not to overcomplicate things. Instead of getting bogged down in intricate financial modeling for every deal, investors should cherry-pick special situations where the valuation mismatch is so obvious that it requires minimal effort to recognize a "50-cent dollar".
3. The Core Advantage of the Small Investor
Ultimately, Greenblatt links small caps and special situations back to the unique structural advantages of being an individual:
No Career Risk: Wall Street managers worry about short-term quarterly tracking errors against their benchmark or getting fired by clients. Individual investors answer to no one and can afford to sit through temporary volatility.
Position Size Freedom: Individual investors can move in and out of smaller, illiquid opportunities without moving market prices.
While Greenblatt concludes that most individual investors might be best served by automated, fundamentally-weighted index strategies, he makes it clear that for those willing to do individual stock research, small caps and special situations represent the fertile ground where an individual actually holds a permanent edge over Wall Street.
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Postscript
The bottom line here is that there is much less competition for information in the small and mid-cap universe. And even less information if you consider corporate restructuring in this sector of the market as well. This is the big advantage the do-it-yourself investor has at his disposal if he is willing to apply himself and do his own work. The media focus on the mega-caps which are all over-owned and over-analyzed. The competition for information in this area of the market is fierce. Don't go there.
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Source
Google Gemini
