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Stock Strategist

What's So Good About an Illiquid Stock?

Nine stocks above $200 with surprising market performance.

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There’s been a fair amount of research into the subject of liquidity--how many shares a stock trades per day--and its effect on stock-market performance. The studies point to one conclusion: illiquid stocks produce higher returns, on average, than liquid stocks. One of my favorite books, The New Finance: Overreaction, Complexity and Uniqueness by Robert Haugen, discusses this subject at length.

There are a couple of reasons why illiquid stocks tend to do better. First, stocks with low trading volumes tend to be small caps. Many of these aren’t included in any major indexes or covered by Wall Street analysts. They are relatively underfollowed by institutional investors and, all else equal (my favorite caveat), sell at lower PEG ratios than larger stocks. You may have heard the saying "No one ever got fired for buying  IBM (IBM)." Well, these stocks ain’t IBM; many institutions simply will not buy small caps. In fact, larger funds couldn’t buy them even if they wanted to because of their size relative to the fund’s asset base.

Mark Sellers does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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