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* Extract written by André Gosselin published in his
book "Investir dans les petites entreprises".
Does the size of the companies explain the differences of
return between these two categories of capitalization? It is not known and one does
not see exactly why. It is possible that the size of the company is only the
demonstration of a deeper phenomenon which is not noticed at the moment. Perhaps
the small capitalization securities have some properties, still unknown, which
enable the investors to generate better yields than those generated by the larger
companies. If such properties exist and if they are crucial, what are they about?
Some researchers have advanced an extremely interesting
explanation, related to the accessibility of the information. To associate the size
effect with the information problem is, in my opinion, one of the most interesting
insights out there. This assumption is almost valid a priori, because it does not
require a whole series of tests to be checked. Indeed everyone agrees to say that
the investors have access to less information (financial, administrative, strategic
and other) with regard to small companies than to the big ones. They are forced to
make increased efforts to get information about the first, otherwise they must
assume a greater risk. The fact that small the companies are subjected to less of
attention from the analysts and the journalists must be compensated by a higher
yield. There is a cost for the effort required in the research of the information
when dealing with the smallest and the junior companies of the stock market, and
this cost must be compensated by a higher yield.
If this assumption proves to be well-founded, the stock
market would not necessarily be inefficient in what is related to the small
capitalization securities. The investors who generate a portfolio return higher
than the average by holding such companies deserve the gain they obtain.
It should also be considered the possibility that the size
effect is the demonstration or the consequence of several phenomena which happen
simultaneously. For example, the acquisitions of companies usually take place with
the purchase of small companies by large ones. In this game, these companies often
agree to pay to the shareholders a price which exceeds the one that is traded on
the Stock Exchange floor. These acquisitions, though unknown from the majority of
the small investors, are real and lead to an increase of the price of the small
companies, often well beyond their intrinsic value. A large company which initiates
this acquisition is ready to pay this price knowing that it eliminates a
competitor and also that this acquisition is less expensive than its internal
growth.
The company size effect on the expected return
of their security is a real phenomenon, but it is not know exactly why this
phenomenon exists. Is this because of the nature and the quantity of the
information which is available about this kind of assets? Is this phenomenon
related to the merger and acquisition activities? Are small companies
real bargains, business opportunities or underestimated values which can
only generate higher profit for the patient investor? The polemic
and the mystery remain unsolved.
André Gosselin
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