Under the Micro(cap) Scope

Despite an attractive long-term risk/return profile, the microcap asset class is often overlooked due in part to perceived higher risks and the assumption that small cap exposure is sufficient for diversification and alpha generation purposes. That said, microcaps have garnered more attention in recent years as investors need their equity investments to work harder in today’s environment, thus seeking higher alpha opportunities. Microcap stocks have several attractive attributes that investors should consider, and they can play a pivotal role within a fully diversified asset allocation. Additionally, characteristics of the microcap market can favor an active approach and investors with a long-term discipline.

Breadth of opportunity set — ripe for stock picking

The microcap stock universe is substantial. In the US, the investable equity universe across all market caps comprises roughly 9,200 stocks. Large caps (stocks greater than $10 billion in market cap) represent the smallest portion of that universe, with nearly 690 stocks. The small to midcap universe has roughly 1,360 stocks available with market caps ranging from $1 billion to $10 billion. In stark contrast, the microcap universe (stocks below $1 billion) is made up of just over 7,200 stocks, comprising nearly 78% of the investable universe (Exhibit 1). The breadth of the microcap market provides ample opportunities for active stock pickers to identify attractive opportunities.

Exhibit 1 – Market Cap Breakdown of Investable US Equities Universe 

Source: FactSet, as of 31 May 2025.

High potential — with room to grow

Businesses don’t start out as multibillion-dollar companies. It’s a simple concept but one that’s easily forgotten once a company has become an established industry leader. Apple, one of the largest companies in history with a market cap near $3 trillion, started from scratch in 1976 as Steve Jobs and Steve Wozniak designed their initial computer concepts out of the Jobs’ family home. While it’s hard to imagine the early days of Apple’s empire, it certainly had humble beginnings.

Growth of microcap companies can provide tremendous potential for investors, especially compared to more mature companies. As you consider the basic concept of a business lifecycle (Exhibit 2), new growth requires innovation and nimbleness — two characteristics that are far more attainable for small businesses than larger, more mature companies. Investors can also find some truly good companies that are dominant in small but growing industries or markets.

It’s important to note that investing in a microcap company does not necessarily mean you are taking a risk in an unestablished company or industry. There are many recognizable businesses in the microcap space possessing competitive advantages and enduring business characteristics we would recognize in larger firms. Many small businesses are leaders and first-movers in their respective industries and/or local geographic regions.

Exhibit 2 – Business Lifecycle

Management accessibility & ownership — two benefits for stock pickers

Management capability and decision making are key components of the overall quality of a business. Conducting due diligence conversations with senior management as well as middle and lower levels of management can provide valuable insights to a long-term investor. Accessing those individuals can be far easier in small companies than in large companies.

Individuals on the senior management teams of microcap companies also tend to own a higher percentage of company shares (Exhibit 3). This can help with interest alignment with shareholders — management decisions ultimately impact the business and the long-term valuation of the company in the market. Bottom-up stock pickers, particularly those focused on a long-term investment, can view themselves as partners alongside the management team (and other employee owners) who are equally vested in the business.

Exhibit 3 – Insider Ownership (%)

Source: FactSet, as of 30 Apr 2025.

Exhibit 4 – Wall Street Coverage

Source: FactSet, as of 30 Apr 2025.

Asset class inefficiency provides opportunity

Part of what makes the microcap universe an attractive hunting ground is that it is arguably one of the last truly inefficient asset classes in the US. Many microcap companies have little-to-no coverage from Wall Street analysts (Exhibit 4), keeping them in the shadows from institutional buyers. Once a company reaches a size to start reporting financials, it will screen properly for those who run quantitative screens; however with little coverage, microcaps attract few institutional buyers.

Additionally, microcaps tend to have lower market liquidity than larger companies, which also plays a role in low institutional ownership, especially for larger asset managers who would struggle to take a meaningful enough position in a stock to positively impact a portfolio while not owning a substantial portion of the microcap company’s outstanding shares. Institutional investment mandates often restrict companies with market caps below a certain level — as do many broad market indices for index construction purposes — which further limits participation in the microcap universe. With fewer institutional investors in microcaps, skilled stock pickers have an advantage in identifying attractive investment opportunities (Exhibit 5). An ancillary benefit of the fact that most microcap companies are too small for institutional investors or index providers to buy is that they do not rise and fall with large fund or ETF flows, which can help mitigate volatility at times.

If a microcap company performs well and delivers quality growth of its business, it’s market cap should eventually reach a level that would interest more institutional buyers — and this can be a great catalyst for returns. Microcap companies are also potential acquisition targets, which benefits long-term investors as they are often rewarded for their ownership via a premium takeout offer.

Exhibit 5 – Competitive Advantage for Nimble, Active Managers ($B)

Source: FactSet, as of 30 Apr 2025.

The active edge

In the still-inefficient microcap and small cap spaces, active managers have proven their ability to outpace their respective broad market indices over the long term (Exhibit 6). Actively managed microcap strategies have also exhibited their ability to outperform small caps while maintaining a similar risk profile.

Although there are myriad factors impacting stock markets at a given time, microcaps tend to blaze their own trail, with unique paths to long-term success. Low correlations of microcaps relative to other areas of the market illustrate the diversification benefits investors might achieve from microcap exposure (Exhibit 7). Given the attractive risk/return profile, some investors have even looked to publicly traded microcap equities as an alternative to private equity (PE), as they have historically provided many of the same benefits — J-curve like growth and higher alpha potential — with fewer disadvantages of PE. Microcaps provide similar exposure to early growth stocks, improved liquidity, higher transparency and potentially less leverage than PE.

Exhibit 6 – Microcaps Risk/Return (%) (as of 31 Mar 2025)

Source: eVestment.

Exhibit 7 – Microcap Diversification Benefits

Source: eVestment. 10-year correlation as of 31 Mar 2025.

Principles that guide our investments

At SJF, we are committed to our intrinsic value philosophy which enables us to invest in what we believe are good businesses at a discount to our estimate of intrinsic value. For the past 20 years, we have invested in stocks at the lower end of the cap spectrum, often following microcap stocks as they grow and transform into larger businesses.

We look for resilient businesses with underappreciated long-term opportunities. Being patient with an owner’s mindset is a durable advantage in a market consistently focused on the next quarter.

Key tenets of our approach