Great Lakes Dredge & Dock Corporation (GLDD), MEDTOX Scientific, Inc. (MTOX): Three Reasons Why Small Caps Rule

When deciding on how much of your portfolio to dedicate to small-cap stocks, it’s important to note many of the perks that come along with buying smaller companies.

The most obvious advantage to small caps is their tendency to outperform their large-cap counterparts. In fact, according to a report from investment consulting firm Ibbotson Associates, small caps increased in value by approximately 12% between 1927 and 2007. During the same period, large caps only increased by 10%. A small cap stock generally has a market capitalization worth between $300 million and $2 billion. So while these companies are smaller than the titans, they are well-established and likely here to stay.

Let’s take a look at three key reasons to invest in small caps, with the corresponding evidence to support each claim.

Trading volume

Small caps generally have a low amount of trading because the stocks are much less well known by the investing community than large caps. This offers ample opportunity for savvy investors to purchase an undervalued stock before the masses realize its value.

It’s best to get in on these stocks when they have a trading volume between $50,000 and $500,000 per day. That means you’ll buy before the majority has had a chance to catch on to the stock’s potential.

With an average volume of about $400,000, Alliance Grain Traders Inc. (TSX:AGT) is in a solid position to profit from important company news when the masses get a hold of the information. And because Alliance Grain Traders Inc. (TSX:AGT) appears poised to profit from increasing global food demand, good news could be coming.

The company cleans, splits, sorts and bags specialty crops in the export market. That means the firm is poised to deliver the grains to the developing countries and their growing middle classes. Its profits are already soaring. Last month’s quarterly report noted the firm grew revenue to $276.4 from $197.4 in the first three months of fiscal 2012, compared to the first three months of fiscal 2011. The firm’s share price increased from nearly $12 to $14 in May, after the news that reached the masses who then wanted a piece of the action.

Less analyst coverage

When an analyst covering a small cap stock raises its ranking, the price is likely to go up. But because there are many analysts covering the same large cap, there is less of a corresponding influx in price.