Investing in Stocks with Low Liquidity

[lou]

Most the companies that are outside of the NZX50 have low daily volume and large bid offer spreads. I was wanting to get your ideas on strategies when you go to buy or sell these shares?

Some of the potential strategies I would like to discuss
1) Give your order to the broker to sell at market? Could be dangerous with a large bid offer spread.
2) Put your offer in at the last sale price. Wait for a buyer/seller to pick it up.
3) Put your offer in at the highest bid price or lowest sale price with sufficient volume and wait for the market to come to you.
4) Other?

I have attached some screen shots of bid offer spreads for a few stocks:
NZE https://www.dropbox.com/s/w85hoepci9rz5ax/picnze.png Capitalisation $14m
SPN https://www.dropbox.com/s/smfvouio27o8mds/picspn.png Capitalisation $86m
TUA https://www.dropbox.com/s/n73uz99wxjna1od/pictua.png Capitalisation $52m

[Snow Leopard]

Hi lou

I just don't even consider them.
The big issue is if you need to sell them that you will take a big loss because of the poor liquidity.

best wishes
Paper Tiger

[lou]

The risk of a large loss because you can’t get out can be mitigated with sensible positionsizing and diversification. Obliviously if you have a large portfolio yourposition size relative to daily volume will be prohibitively risky.

@PaperTiger small caps do have a higher rate of return so why not consider them.

[CJ]

Most the companies that are outside of the NZX50 have low daily volume and large bid offer spreads. I was wanting to get your ideas on strategies when you go to buy or sell these shares?

Some of the potential strategies I would like to discuss
1) Give your order to the broker to sell at market? Could be dangerous with a large bid offer spread.
2) Put your offer in at the last sale price. Wait for a buyer/seller to pick it up.
3) Put your offer in at the highest bid price or lowest sale price with sufficient volume and wait for the market to come to you.
4) Other?

I have attached some screen shots of bid offer spreads for a few stocks:
NZE https://www.dropbox.com/s/w85hoepci9rz5ax/picnze.png Capitalisation $14m
SPN https://www.dropbox.com/s/smfvouio27o8mds/picspn.png Capitalisation $86m
TUA https://www.dropbox.com/s/n73uz99wxjna1od/pictua.png Capitalisation $52mOther than NZE where a takeover is expected (now public) the range is only 5c. I have in the past just set the level I want and hope it all gets taken. I do relatively small parcels for small stocks (say 5-10k).

I do look at past trade history - volume and volitility. The likes of BFW the price was looking interesting but most trades are only for 1,000 shares (obviously all the punters could afford on their visa at the IPO) so not worth while as the next trade might jump 10c. Other shares the volatility might be quite small even though the buy/sell looks big.

I did miss out once where only 1000 shares of a 10000 parcel got sold in the 30ish days a trade stays live for.

[BIRMANBOY]

Wishfull thinking methinks... if they had a "higher rate of return" there would be more people trading them..dont you think? You may get lucky and get a good one but the others will be stuck where the sun dont shine..thereby nullifying your "good one". Diversifying is good but but diversification among low performers, illiquid semi-specs will guarantee a do nothing, go nowhere position.
The risk of a large loss because you can’t get out can be mitigated with sensible positionsizing and diversification. Obliviously if you have a large portfolio yourposition size relative to daily volume will be prohibitively risky.

@PaperTiger small caps do have a higher rate of return so why not consider them.

[Snow Leopard]

The risk of a large loss because you can’t get out can be mitigated with sensible positionsizing and diversification. Obliviously if you have a large portfolio yourposition size relative to daily volume will be prohibitively risky.

@PaperTiger small caps do have a higher rate of return so why not consider them.


Because of the poor liquidity of such stocks the risk as a percentage of invested amount is high. In order for them to be a sensible buy then the assessed reward needs to be proportionally higher as well, and most simply do not stack up.
And then you still can not buy much of each one.

best wishes
Paper Tiger

[lou]

Wishfull thinking methinks... if they had a "higher rate of return" there would be more people trading them..dont you think? You may get lucky and get a good one but the others will be stuck where the sun dont shine..thereby nullifying your "good one". Diversifying is good but but diversification among low performers, illiquid semi-specs will guarantee a do nothing, go nowhere position.

I did some comparison of returns for the NZX Small Cap and NZX50.



NZX Small Cap
NZX50
Variance



Return
Index
Return
Index
Return
Index


YTD
37.8%
185
22.0%
155
15.8%
31


YE2011
-4.2%
134
-2.4%
127
-1.8%
8


YE2010
5.6%
140
3.4%
130
2.2%
10


YE2009
23.4%
133
18.9%
126
4.5%
7


YE2008
-32.9%
108
-31.6%
106
-1.3%
2


YE2007
1.2%
161
-0.2%
154
1.4%
6


YE2006
27.2%
159
20.8%
155
6.4%
4


YE2005
0.0%
125
10.6%
128
-10.6%
-3


YE2004
24.7%
125
15.8%
116
8.9%
9



0%
100
0%
100
0%
0


Smalls caps compunded return 7.07%p.a, NZX50 compounded return 4.99%p.a

There is more varinace in returns in small caps but they do have a higher return.

[percy]

I suppose they are like choosiing a wife.Take your time.
TUA which you quote is a case in point.2 months ago there were plenty of buyers,no sellers,then it changed to a number of sellers and no buyers,today the buyers are back.
AWF has been very much the same.Now these are very good small companies which should out perform the market.
Then there are the very illiquid stocks such as PAZ on NZ unlisted market,HIT on asx,which sometimes do not trade for 6 months or more.I hold both.I brought SCY while they were delisted and tried to buy HBY when they were Renouf and delisted.If you have a long term time frame the returns can be great.I look at their balance sheet strength,weak companies will fail.
On AsX thread Steve Fleming has posted some great advice on illiquid options and done very well.I have both MNF and CAJ in Aussie.MNF has gone from 17cents to $1.05 in under a year.CAJ is at present enjoying a great run.
Research,research,research and patience result in good returns.
Do not fall in love with any stock.Spread you risk around 10 stocks.Do not place large bets.
Total sum invested in those 10 stocks should not exceed 10% of your total portfolio.ie no more than 1% in any one illiquid stock.Neither use borrowed money to fund these stocks.

[BIRMANBOY]

I applaud your research...and assume its correct but not such a big difference really and when you take into account two factors being (1) any dividends to speak of? (easy to get 6/7% on selected NZX50) and also as previously pointed out very low liquidity. Not particularly compelling and I still doubt the claim of higher return when you look at the big picture.
I did some comparison of returns for the NZX Small Cap and NZX50.



NZX Small Cap

NZX50

Variance




Return

Index

Return

Index

Return

Index



YTD

37.8%

185

22.0%

155

15.8%

31



YE2011

-4.2%

134

-2.4%

127

-1.8%

8



YE2010

5.6%

140

3.4%

130

2.2%

10



YE2009

23.4%

133

18.9%

126

4.5%

7



YE2008

-32.9%

108

-31.6%

106

-1.3%

2



YE2007

1.2%

161

-0.2%

154

1.4%

6



YE2006

27.2%

159

20.8%

155

6.4%

4



YE2005

0.0%

125

10.6%

128

-10.6%

-3



YE2004

24.7%

125

15.8%

116

8.9%

9




0%

100

0%

100

0%

0



Smalls caps compunded return 7.07%p.a, NZX50 compounded return 4.99%p.a

There is more varinace in returns in small caps but they do have a higher return.

[lou]

@Birmanboy The return quoted included dividends


@Percy "Research, research, research" How do you approach research for small cap stocks?

One of the reasons I like well know stocks is it is easy to get quality research on the company from analysts, websites, stock brokers, etc. However if it is easy for me it is easy for everyone else hence why it may be possible to pick underpriced quality companies in the small cap sector. Any tips?

[ENP]

One of the reasons I like well know stocks is it is easy to get quality research on the company from analysts, websites, stock brokers, etc. However if it is easy for me it is easy for everyone else hence why it may be possible to pick underpriced quality companies in the small cap sector. Any tips?

The obvious tip would be to do lots of research on a handful of small cap stocks wouldn't it? As you say, there are less people looking at small cap stocks so you will have a bigger advantage if you know a lot about the company.

And with your small cap index vs NZX 50 index, I never see these as a meaningful comparison. If you are looking to invest in individual companies then it has no real worth to you.

[lou]

@ENP The indexes were an expample that small caps had a decent return. An earlier poster was suggesting they did not pay dividends and there was no capital gain.

Investing in quantity companies should see you beat the index.

[percy]

[

@Percy "Research, research, research" How do you approach research for small cap stocks?

Start by ringing the company and getting a copy the annual report and latest interim report.Go through that until you know it backwards,keeping an eye on cash flow,and in the balance sheet make sure current assets far excede current liabilities.Make sure equity ratio is 50% or more.Most small companies run out of cash.If you have any questions ring the CEO,and at the same time ask him if there are any articles on the company you should read.Check out the company's website.If there is a thread on sharetrader,read it from start to finish.You can post questions here. .If you are still happy,just buy a small parcel of shares.Then if they are doing things right add to them.If they are not the shares will be worthless,so be careful.

[Snow Leopard]

I did some comparison of returns for the NZX Small Cap and NZX50....
...Smalls caps compunded return 7.07%p.a, NZX50 compounded return 4.99%p.a

There is more varinace in returns in small caps but they do have a higher return.

The NZX Small Caps Index consists of ALL the stocks on the main board that are NOT in the NZX50 (none of the NZAX stocks are in this index).

The index is dominated by it's bigger stocks and which includes 25 stocks that meet my definition of liquid (greater than $50,000 day average turnover, less than 8 days in the last 64 with low turnover).

best wishes
Paper Tiger

[BIRMANBOY]

Ok...well there's dividends and there's DIVIDENDS...what figures were you working with? I get approx 8% plus as a gross dividend across my selection plus on top of this quite a few have imputation credits. If you take a broad spectrum dividend average across the index ...my guess would be it would be considerably lower than that. Not trying to get in a P*****g contest but as I said theres subtleties I dont believe you have taken into account.

[QUOTE=lou;386298]@Birmanboy The return quoted included dividends

[lou]

I got my figures from the gross indexes on yahoo finance

[Snoopy]

Smalls caps compunded return 7.07%p.a, NZX50 compounded return 4.99%p.a

There is more varinace in returns in small caps but they do have a higher return.


Don't listen to all the nay sayers Lou. Your research that says small caps will generate a higher return is correct and similar studies all over the world will corroborate your result.

The problem arises when you try to translate these above average results into reality by buying and selling. That is when the problem of the spreads and liquidity comes in. When you start to trade a decent number of shares you 'move the market'. Thus when buying a share you end up paying more than you expect and when you sell you end up accepting less than you expect. The spread and liquidity problems mean in practice that almost all of this outperformance on paper for smallcaps dissipates.

So you are stuffed. or are you?

If you are a small investor who only trades the number of shares traded daily and that represents your entire smallcap holding then I think trading smallcaps will give the outperformance promised.

I started out this way, then as I became more successful realised that I had one or two holdings that I would not be able to sell if I wanted to. I agonized over what to do. Then I decided because I had put so much homework into choosing my smallcaps, the chance that I would want to completely sell out of them was almost nil. There was certainly enough liquidity in the market to reduce my position by say 20% in a week if I so wished. So I decided that was good enough.

SNOOPY

[percy]

Don't listen to all the nay sayers Lou. Your research that says small caps will generate a higher return is correct and similar studies all over the world will corroborate your result.

The problem arises when you try to translate these above average results into reality by buying and selling. That is when the problem of the spreads and liquidity comes in. When you start to trade a decent number of shares you 'move the market'. Thus when buying a share you end up paying more than you expect and when you sell you end up accepting less than you expect. The spread and liquidity problems mean in practice that almost all of this outperformance on paper for smallcaps dissipates.

So you are stuffed. or are you?

If you are a small investor who only trades the number of shares traded daily and that represents your entire smallcap holding then I think trading smallcaps will give the outperformance promised.

I started out this way, then as I became more successful realised that I had one or two holdings that I would not be able to sell if I wanted to. I agonized over what to do. Then I decided because I had put so much homework into choosing my smallcaps, the chance that I would want to completely sell out of them was almost nil. There was certainly enough liquidity in the market to reduce my position by say 20% in a week if I so wished. So I decided that was good enough.

SNOOPY

Sage advice.!!! I have nothing further to add.!!! lol.