A reminder of a topsy turvy madness in small cap valuations

Here’s a small mind experiment. I’ve got two investments to offer you. They are almost identical in what they do and priced at a similar valuation, but the first (company A) is very profitable and spits off lots of free cashflow, while the second (company B) is losing money and requires constant cash funding through debt and share issues. Which company would you rather invest in? Clearly, only a madman would prefer to invest in company B. But I hope to show you that there are very many madmen around…Quality amp; Value – uneasy bedfellowsAny rational investor should prefer investing in higher quality companies to lower quality companies. So he’s likely to bid up the price of higher quality companies to a premium valuation, while lowering his bids on the lower quality companies to a discount. In theory this is the way the market should work. In order to investigate whether the theory holds true I’ve created a few scatter plots using the Stockopedia StockRanks. On the horizontal axis I’ve used the Value Rank, while on the vertical axis I’ve used the Quality Rank. These ranks score every stock in the market as a…