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I Found a compelling argument that people managing smaller portfolios should focus their research on smaller cap companies < 5 billion, even < 1 billion market caps.

They usually only have 1 arm of business. Which makes it much easier to analyze.

It's much easier to find "5-10 baggers" at this level.

Larger institutions aren't allowed to enter some stocks that are below $5. Even then it might not be worth their time to analyze such companies, as they can't even invest too much of their capital without taking up a lot of the float. One example I found was a fund invested something like a measly $300,000 into a uranium mining company (Forsys Metals Corp i think?), which caused the shares to increase by 30%.

I heard 95% of micro-cap stocks are garbage, but 5% of them are actual diamonds in the rough and they do exist if you try to scout them out. Via looking at companies with double digit revenue growth, a lot of insider trading, an outstanding management team and so on.

Also historically, small cap companies have collectively outperformed the S&P 500.

Therefore does it not make more sense for someone to focus more on screening for small/micro cap stocks, and building a portfolio that consits of mostly small / micro cap companies? What are the downside of this approach?

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  • Microcap stocks are thinly traded, and therefore highly volatile. They are -- to be polite -- highly speculative. You "trade" them, not invest in them. – RonJohn Jan 31 at 3:59
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I'm afraid, your question is quite generic. There are profitable trading strategies in different segments of the market. The question is not which segment you should exploit. The question is: did you find a strategy?

By the logic similar to yours: most desks at investment banks have mandate to trade only one asset class. So any schemes where you trade currencies against commodities or where you trade stock indices versus other macro securities is where you have potential edge... No trader working for the man wants to be in the office 16 hours a day. So any strategy necessitating checking your account at 5 am and 9 pm (even for a minute) is where you potentially have the edge... But you have to discover a strategy. There are many retail traders out there.

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American Association of Individual Investors (AAII) publishes a microcap value stock list called Shadow Stock Portfolio, for the reasons you mentioned.

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