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Analyst neglect stunts smaller caps

Analyst neglect of UK small-cap and mid-cap stocks subtracts £8 billion ($14.7 billion) from the capitalization of the UK equity market, according to UK research boutique Equity Development. Comparing the valuations of stocks for which there are nil, one, two, or more than three analysts publishing research, Equity Development found discounts for neglect in 75% of the sectors for which there is useable data.

The average discount for stocks with no coverage is as high as 32%, while the average discount for stocks suffering from relative neglect is 26%.

A lack of research coverage also has a significant impact on liquidity, Equity Development found. Taking the bid-offer spread as a proxy for liquidity, it found that stocks with no analyst coverage have spreads that are on average 35% higher than stocks of the same size with one analyst. Stocks with just one analyst covering them have spreads on average 26% higher than stock of the same size with two analysts.

Surprisingly dramatic

The relationship between research, valuation and liquidity works in both directions. A lack of analyst coverage leads to lower valuations and reduced liquidity. At the same time, demand for research falls as a company?s market capitalization or trading volumes fall.

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