A good small cap company does not always translate into a good small
cap investment when its valuation needs a reality check.
How many times as investors have we bought shares of small cap
growth stocks priced off hype by investment bankers, analyst calls and
portfolio managersí picks in the media? If you purchased shares in Patient Home
Monitoring Corp. or a slew of other small cap healthcare stocks earlier this
year you will know what I mean, unfortunately.
Good information and analysis is critical for small cap investments.
But acting on the information from a consensus view from others can be
precarious for investing in small cap stocks.
Informational herding arises in situations where investors observe
the actions of others, derive information from them and then, seemingly,
disregard their own information to follow the majority action. Applying this
idea to small cap stocks, one could argue that recommendations by a visible
group of small cap fund managers and newsletter writers which induce others to
follow will cause such stocks to jump in one direction. This is when a share price will deviate far from the small cap stockís true fundamental value.
This herding effect was in full force earlier this year. Fund
managers and investment gurus alike kept recommending to investors to buy the
same group of small cap health care stocks, already trading at a lofty
Were these stock prices sustainable? No. Today a majority of these
stocks are 60-80% down in value from their trading highs this year.
When stock valuations are too high, so are expectations. Too high
expectations will always lead to disappointment, under performance and, often,
share price collapse. This was the case for small cap health care stocks, as
any negative triggers, operational or not, dramatically discounted these
stocks' valuations and the selling herd trampled over retail investors.
Why pay for this hype? Buy small cap growth stock when its valuation
is still reasonable, which allows the Company to generate positive surprises
and exceed on lower expectations to outperform. Avoid making buying decisions
solely based on a recommendation from fund managers in the media.
More importantly, one must realize what makes a good company does
not always translate to what makes good investment if the valuations levels
That said, Patient Home Monitoring Corp. may well be a good small cap company, but it was bad investment for those small cap investors who
followed the herd.
This article is for informational purposes
only. This article is based on the author's independent analysis and judgment
and does not guarantee the information's accuracy or completeness. The
information contained in this article is subject to change without notice, and
the author assumes no responsibility to update the information contained in
this article. The information contained within this article should not be
construed as offering of investment advice. Those seeking direct investment
advice, should consult a qualified, registered, investment professional. This
is not a direct or implied solicitation to buy or sell securities. Readers are
advised to conduct their own due diligence prior to considering buying or
selling any stock.