Micro Cap or Micro Crap Stocks?

The endless quest for hidden gems in the stock market

April 2025. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Small-cap stocks have struggled to outperform since Banz’s 1981 study on the size factor
  • Micro-cap stocks behave similarly to small caps
  • Structural shifts have made them less appealing, with lower valuations being their only advantage

INTRODUCTION

The world is filled with stories that seemed true but were later proven wrong, such as:

  • Cats were witches’ spies (Medieval Europe): People in the Middle Ages believed that black cats were evil and associated with witches. This led to widespread cat killings – ironically, reducing the natural predators of rats, which contributed to the spread of the Black Death.
  • The Great Emu War (Australia, 1932): Australians once thought they could win a war against…emus. The government sent soldiers with machine guns to eliminate an emu overpopulation problem. The emus dodged bullets, outran the soldiers, and ultimately won the war.
  • Victorian-era people feared “Train Madness”: When trains were invented, people thought going over 30 mph would melt your brain or make you go insane. In reality, the only madness was the expensive train tickets.

Finance is full of similar misconceptions. Take, for instance, the belief that higher risk leads to higher returns – a notion debunked by research on the low-volatility factor. Another persistent myth is that small-cap outperform large-cap stocks. This idea sticks around because it tells a compelling story – who wouldn’t want to discover the next Amazon or Microsoft before the rest of the market?

However, the evidence against small-cap outperformance has grown stronger. In response, some market participants have shifted their focus to micro-caps, a trend we will examine in this research article.

SMALL VERSUS LARGE STOCKS

The primary argument for small-cap stocks comes from data in the Kenneth R. French Data Library, which reports a CAGR of 11.7% for small caps versus 9.9% for large caps since 1926.

It’s important to note that these returns are calculated before transaction costs, and trading smaller stocks is typically more expensive than trading larger ones, meaning the actual outperformance is likely lower.