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Conclusion

The allure of investing in hidden gems—businesses that other investors have not discovered or have ignored—underlies all of the investment strategies described in this chapter. The strategy of investing in smaller, less followed companies is the strategy that is most accessible to individual investors. By putting your money in companies with small-market capitalization that are lightly held by institutions and not followed by analysts, you may be able to generate higher returns. Whether these higher returns are just compensation for the higher risk of these stocks—they are less liquid and information may not be as freely available—or excess returns is the key question that investors have to answer while following this strategy. Your odds of success improve if you can focus on stocks with lower transactions costs and more stable earnings that are priced attractively.

A more risky strategy is investing in companies as they go public by bidding for shares in these companies at the initial public offerings. While the empirical evidence suggests that these stocks are generally underpriced (by about 10% to 15%), this strategy has three problems. The first is that you are likely to get all the shares you request in companies that are overpriced and less than your requested number in underpriced companies. Thus, your final portfolio will earn lower returns than the empirical evidence suggests. The second problem is that a strategy of investing in only IPOs will have to be short term (almost all of the price jump occurs on the first day of trading and can dissipate if you hold the stock too long) and results in portfolios that are overweighted in the hot IPO sectors (technology in 1999, for instance). Finally, the number of IPOs in a year reflects the market mood, dropping off significantly in bear markets and rising in bull markets. As an investor, you may very well find nothing to invest in when confronted with a cold market and too many offerings to look through in hot markets.


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