The Hidden Cost of Illiquidity, and What Thin Volume Does to Your Valuation

When you compare your company with similar businesses, the valuation gap can be hard to explain. You may notice another company your size, in your sector, with margins and growth that look a lot like yours, is trading at a noticeably higher multiple. You go back through the story looking for the thing you're missing, some strategic edge or catalyst that would justify the gap. Often there isn't one. Part of what separates your valuation from theirs has nothing to do with the business at all.

Falling volume is easy to read as an optics problem that will right itself next quarter. What that reading misses is that thin volume also carries a price, and that price is quietly embedded in your valuation whether or not anything is wrong with the company.

Investors pay less for a share they may struggle to sell. A position that is hard to exit without moving the price against yourself is worth less than an identical claim on the same cash flows that trades freely, and the market discounts it accordingly. So the volume that quietly left your stock didn't just make the tape look worse. It changed what buyers are willing to pay to step in.

#Investors Pay Less For What They Can't Easily Sell

This is one of the most established findings in market structure. In their foundational 1986 study, Yakov Amihud and Haim Mendelson showed that assets with wider bid-ask spreads, the classic marker of illiquidity, command higher expected returns, which is the same as saying they trade at lower prices¹. The harder a stock is to trade, the more return an investor demands to hold it, and the less they will pay for it today.

That extra return is compensation for liquidity risk. Investors also care about whether an asset becomes even harder to trade when markets are under stress, because that is often when they most need to sell. These liquidity risks matter more during economic downturns and periods of tight funding.

How large the effect gets depends on how severe the illiquidity is. At the extreme, studies of restricted stock, shares in a public company that legally cannot be traded for a period, have found average discounts of around 30% against otherwise identical freely trading shares (Silber, 1991)². A listed small-cap that simply trades thinly sits nowhere near that extreme, but it sits on the same spectrum. Aswath Damodaran's work on illiquidity discounts puts numbers on the everyday version. For a highly liquid, higher-priced stock the round-trip cost of trading can be under half a percent of the price, while for a thin, low-priced name it can run into double digits³. Every buyer sizing a position bakes some version of that cost into the price they are willing to pay.

Source: Aswath Damodaran⁴

#It Shows Up As A Higher Cost Of Capital

For a public company this reaches straight into the cost of capital. As the IR research firm IR Impact put it in early 2025, higher liquidity supports valuation precisely by lowering the returns investors require, which reduces a company's cost of capital and makes it more competitive when it goes to raise money⁵. The reverse is just as true. Thin liquidity raises the return the market demands, and a higher required return is, by definition, a lower valuation on the same set of forecasts.

Academic work has traced that mechanism through to firm value. A 2023 study in the Journal of Financial and Quantitative Analysis modeled how a wider bid-ask spread raises a firm's cost of capital and, through that channel, lowers its cash reserves and its overall value⁶. For the reader this shows up in concrete places. A lower valuation makes it harder to use your shares to buy other companies. Equity raised to fund growth costs more in dilution. Stock-based compensation buys less when the shares are discounted. None of that traces back to the operating business. It follows from how easily the stock trades.

#The Discount Feeds On Itself

This cost also compounds. Thin volume widens spreads, and wider spreads make the stock more expensive to trade, which pushes liquidity-sensitive institutions further away. Their absence thins volume again, and it also erodes the case for analyst coverage, since the sell side is reluctant to commit an analyst to a stock institutions aren't trading. Equally, the loop runs the other way too, stronger coverage narrows spreads and improves trading efficiency, which is the same cycle in reverse. The company and its stock liquidity affect each other. Therefore, problems in either the business or the market can therefore have a bigger ripple effect.

Left alone, the discount doesn't settle at some fair level and hold there. It tends to deepen, quarter after quarter, for reasons that have very little to do with performance.

#The Input You Can Still Widen

Liquidity has several drivers, and most sit outside any IR team's reach. IR cannot directly change index membership, passive flows, interest rates, or sector sentiment. It can’t affect the position minimums that large funds run, the share of your float locked up by insiders and long-only holders, or the rate cycle. Too often, IR effort is spent trying to overcome structural constraints that better communication alone cannot fix.

One input remains within reach. It is the traded float you can widen by broadening who knows the stock exists. The clearest version of that today is the retail investor base. Individual investors now account for roughly 30% of daily US equity volume, according to Goldman Sachs, and the pattern increasingly looks structural rather than a passing phase⁷. Retail investors are not bound by index rules or minimum position sizes. They can find, evaluate, and trade a small-cap on their own terms, which makes them the one pool of demand a company can actually enlarge through its own effort.

It is also the audience most legacy IR programs were never built to reach. A jargon-heavy newswire release and a static deck are designed for institutions that, for the structural reasons above, may already be out of range. Widening the traded float means reaching the investors who are still reachable, in the places they actually look, with a stock story that resonates.

#What Thin Trading Is Costing You

So the more useful question isn't why your multiple trails a peer's, or when volume will drift back on its own. It is what thin trading is quietly costing you across your cost of capital and your deal currency, and which single input you can still widen. That reframe is where the practical work starts.

See how retail-ready your stock story is. Digitonic's free Retail Readiness Assessment benchmarks your investor communications against peers and shows you where you are losing ground.