With a nearly 30-percent gain in 2017, shares of industrial products maker Handy & Harman are outpacing hot stocks like Google-parent Alphabet and Visa. Yet few on Wall Street have ever heard of the $412-million market-cap company, in large part because no sell-side research analysts publish any estimates of its earnings.
That lack of information is a boon to Paul Sonkin, a portfolio manager at Gabelli Funds, whose firm owns shares of Handy & Harman. Sonkin estimates approximately 15 percent of the companies in his portfolio have no sell-side analyst coverage, leaving them more likely to be overlooked.
“What we’re looking for is some kind of edge, and if there are fewer analysts covering a stock there’s a greater chance that it will be mispriced,” he said.
Like Sonkin, other fund managers are increasingly turning to small-cap companies with no sell-side coverage, hoping an industry-wide pullback in analyst research will allow them to buy into more unknown companies before they get on other investors radar.
Top-performing fund managers at Fidelity, Janus Henderson, Hodges Capital and Baron say that the decline in research coverage means that they are seeing more small-cap companies that are mispriced and potentially undervalued, giving firms that have the capacity to conduct their own research an advantage over the long term.
Overall, the number of companies in the small-cap benchmark Russell 2000 that receive no formal attention from Wall Street research firms has jumped 30 percent over the last 3 years, according to a Reuters analysis.
That cutback has left a broader number of small-cap companies including household names Tootsie Roll Industries, Revlon, and Ruby Tuesday—essentially a black box for investors without the time or resources to analyze a company. Investors in index funds that track the Russell 2000, meanwhile, are putting money into firms that few on Wall Street know anything about.
Numerous academic studies have shown that an analyst initiating coverage of a stock pushes share prices higher, in part by improving investor recognition of the company and increasing its liquidity. A study published in Financial Management in 2008 found that stocks that traded for at least one year without research coverage jumped by an average of 4.8 percent once an analyst began tracking the company.
Investors have little way of knowing in advance when a sell-side brokerage firm will initiate coverage of a company, however, adding the risk that it may be a long time before other portfolio managers recognize a company and boost its shares.