There is a striking paradox sitting in plain sight in the allocation decisions of sophisticated investors. The intellectual case for owning smaller companies, with all the dispersion and alpha potential that implies, is widely accepted. Yet the capital flows tell a different story entirely: the money crowds into private equity while a comparable opportunity in public microcaps goes largely ignored.
Verdad makes this tension explicit1. The average private equity deal carried a market capitalization of around $130 million in 2025, placing it squarely in the same size territory as public microcaps, which by definition sit below $400 million. The two universes also exhibit similar levels of dispersion, meaning the theoretical potential for alpha generation is roughly comparable.
But on valuation, the similarity ends. Private equity, even after adjusting for the now-commonplace EBITDA add-backs that run approximately 29% of reported EBITDA, trades somewhere between a flat premium and a 40% premium to public markets. Public microcaps, by contrast, trade at measurable discounts to the broad US equity market: roughly 20% for US microcaps, 30% for European, 40% for Korean, and 50% for Japanese.
The implication is hard to escape. Verdad observes that "private equity is one of the most competitive, oversaturated investment strategies of all time, and the flood of money into the asset class has pushed valuations to crazy heights." Buying expensive assets in a crowded market is not typically how alpha is generated.
Performance Drag, Not Fundamental Failure
The more obvious rejoinder is that microcaps have simply underperformed, and the discount reflects rational market pricing. The performance record does present a genuine hurdle. In the US, microcap performance was, by Verdad's characterization, "abysmal from 2004 to 2024," interrupted only by short recovery windows following the 2008 crisis, the 2015 oil crash, and COVID. European microcaps have fared worse, delivering essentially straight-line relative underperformance. Japan and South Korea are exceptions, with microcaps outperforming small caps through 2024 before suffering 9% and 20% drawdowns this year.
Yet the fundamental picture does not match the performance story. Verdad notes that "microcap fundamentals have held up fine versus an index like the broader Russell 3000, for the most part, whether looking at quality metrics, like gross profit/assets, or trailing EBITDA growth." If the businesses are not deteriorating, the discount reflects something other than earnings disappointment.
The Anatomy of Neglect
Verdad's diagnosis is deliberate and pointed: "We believe investor neglect, not bad financial performance, has driven the wide valuation discounts in public microcaps." The mechanism is social and institutional rather than analytical. The firm poses a series of questions that cut to the core of how investment decisions actually get made. How many colleagues work in private equity versus small or microcap public equity? When did an investment committee last get excited about a single-name microcap allocation versus a co-investment? How many pitches per week arrive from private equity versus microcap managers?
The answer, for most institutions, is obvious. The infrastructure of the investment industry, its relationships, its marketing apparatus, and its committee culture, tilts decisively toward private markets.
The conclusion Verdad draws is sharp: "Investors broadly agree that smaller companies offer greater opportunity for skilled investors. Then they crowd into the most competitive market for owning them." The smallest public companies are not cheap because investors have rejected the idea that smaller companies are attractive. They are cheap because investors have chosen to pursue those companies almost exclusively through private equity.
What This Means for Advisors and Investors
1. Valuation discounts of 20% to 50% in public microcaps represent a structural opportunity that does not require superior stock-picking to recognize, only the willingness to allocate where the crowd is not.
2. Private equity is not a substitute for small-company exposure. The size overlap is real, but the valuation premium paid for PE access is also real, and it compounds against future returns in ways that are difficult to overcome.
3. Microcap fundamentals are holding. Poor recent performance has been a price phenomenon driven by neglect, not a reflection of deteriorating business quality. For advisors building long-duration portfolios, that distinction matters.
4. Active management and factor premia have historically worked better in smaller stocks. Verdad has documented both points previously. The valuation discount amplifies these advantages by improving the starting point.
5. Institutional behavior, not market efficiency, is setting microcap prices. That is the definition of a structural mispricing. It may persist, but it also means the opportunity does not require a catalyst to be real.
Footnote:
1 Verdad. "Too Small to Matter?" Verdad Capital, 2025, mailchi.mp/verdadcap/too-small-to-matter-1353895. Accessed 24 July 2026.
