What do the following stocks have in common?
Yes, they each trade on the Nasdaq.
But look closer ...
Wall Street loves these four stocks. Not only are they all large caps, trading more than 10 million shares a day on average, but they also happen to occupy three industries that analysts also love to follow, according to former Wall Street analyst Stephen T. McClellan.
In his recent book, Full of Bull, McClellan notes, "Technology, telecommunications, and health care are the most over-researched [industries], covered by the most analysts."
That makes sense -- tech, telecom, and health care are three of the sexier industries out there, having produced big winners such as Dell
Some individual investors may appreciate the abundance of Wall Street coverage on these stocks. After all, there will never be a lack of professional opinion on company developments and events.
Unfortunately, by following these heavily analyzed firms, large-cap tech, telecom, and health-care investors may be also subjecting themselves to lackluster returns.
A 2005 study by John A. Doukas, Chansog (Francis) Kim, and Christos Pantzalis titled "The Two Faces of Analyst Coverage" looked at a panel of firms between 1980 and 2001 and found that "abnormal analyst coverage causes stocks to trade at prices away from fundamental values, which is detrimental to investors and market's ability to allocate capital efficiently." And perhaps more importantly, "We document that negative excess (weak) analyst coverage is linked with stock discounts."
In other words, the fewer analysts there are covering a stock, the better chance you'll have at finding some sweet deals in the market.
In this case, Wall Street's loss is your gain. As McClellan explains, "Small stocks present the individual investor with a better prospect of undiscovered value and the potential to achieve greater prominence in the future as their market caps expand."
This is the mission of our Motley Fool Hidden Gems team when they search the small-cap universe each month for promising stocks. Among other things, the team recommends that you look for small, ignored companies that are also:
- Led by a dedicated founder (or founders).
- Fiscally conservative.
- Profiting from a wide market opportunity.
These traits are shared by some of the best-performing stocks of all-time, including Wal-Mart and Dell ... but Wal-Mart and Dell today are each covered by more than two dozen analysts. That's why you should consider small caps.
Applying the time-tested methods above to search the small-cap universe has made Hidden Gems successful. Since inception, the team's picks are ahead of the market by more than 18 percentage points on average.
You can take a look at all Hidden Gems' former and present superior small-cap picks with a free 30-day trial to the service. There's no obligation to subscribe.
If Fool contributor Todd Wenning could run out of a Major League bullpen to one song, it would Van Halen's "Judgment Day." He does not own shares of any company mentioned. Wal-Mart and Dell are Motley Fool Inside Value choices. Dell, eBay, and Yahoo! are Stock Advisor picks. The Fool's disclosure policy still hasn't found what it was looking for.