In his seminal book One Up On Wall Street, fund manager Peter Lynch talks about how the average investor can 'beat the Street' by owning companies that fund managers don't follow, either because they're too small or not well known.
That's harder in Australia because our market is so small, and there are plenty of fund managers that buy small-cap stocks. However, one guaranteed way for small investors to get an edge over the experts is by buying illiquid companies – where only a tiny volume of shares are traded each day.
It can be tough, if not downright impossible, for even smaller funds to build an adequate position in a company when only $30,000 worth of shares change hands each day. Here are four companies that could fit the criteria:
Tower Limited (Australia) (ASX: TWR)
A small New Zealand insurer that has been through some tough times recently, most of the value is now gone from Tower shares due to the recent takeover offer that was made for the company. However for a few months the company was a clear opportunity for small buyers, with only a few thousand dollars worth of shares traded each day.
CBL Corp FPO NZX (ASX: CBL)
A recently-listed Kiwi insurer that contributor Ed Vesely identified as his top stock pick for October last year. Following some research, I have decided that I also like CBL a lot. Management and the board own more than 50% of the company between them, and niche products combined with a high level of profitability compared to regular insurers make the company worth a closer look. A number of NZ fundies also like CBL, but with just ~10,000 shares changing hands each day, they'll struggle to build a position.
Macquarie Media Ltd (ASX: MRN)
An Australian value investing fund manager recently wrote about this radio station and media company, and identified it as a possible opportunity that was too illiquid for them to build a stake – again due to very high stakes held by major shareholders. I haven't looked at Macquarie Media myself, but it is another reminder that unique opportunities are out there for household investors which are largely unavailable to fund managers.
Reject Shop Ltd (ASX: TRS)
Unlike the above companies, plenty of Australian funds own Reject Shop, as it is part of the S&P/ASX300 (INDEXASX: ^AXKO) (ASX: XKO) index. However, there are only 29 million shares on issue, which can lead to volatility and price swings – especially when fund managers are forced to sell as we saw in 2015. The patient investor can use these to their advantage, and the company looks interesting at today's prices.
Foolish takeaway
Of course, just because a company is illiquid doesn't mean that you should own it. There are additional dangers for the household investor, especially if they sell in a hurry as there is no guarantee that there will be a market for their shares. Bad news can also have a disproportionately more severe impact on the share price, given that there are fewer buyers and sellers must discount further in order to achieve a sale. However for the patient and the risk-tolerant, illiquid companies can provide unique opportunities that aren't available to many fund managers.
