When one hears the phrase “small cap stocks,” quick things that come to mind are risk, fraud and poor investment. It is probably because the media has always highlighted the negative side of investment in small cap companies. And it makes sense to have concerns about putting funds in small cap stocks. However, it is equally important to bear in mind that large cap companies have also fallen prey to scams and internal fraud.
Background
Speaking of small cap stocks, these are stocks that have small market capitalization. In numbers and figures, these stocks have market caps between US $250 million and $2 billion. Also, like most stocks, the trading of small cap stocks takes place through exchanges. However, in their case, these exchanges happen to be ones with lenient requirements for stock listings.
Pros of Investment in Small Cap Stocks
Now, let’s delve into the reasons why one should look for investment opportunities in small cap stocks:
- Huge prospects of growth
Undoubtedly, investments in large cap companies have comparatively a lower risk factor. But, the potential and rate of growth are exponentially higher for small cap investments. For instance, a large company with a $1 billion cap has slight chances of doubling in size in the same time as a small cap company.
- Few institutional investors
It is another perk of small cap investments. Actually, it is quite rare to see mutual funds investing in the small cap market. Thus, individual investors have an opportunity to get in before institutional investors do. Also, there are prospects of huge returns when mutual funds finally buy shares and push up the stock price.
- An under-reported market
Usually, small cap stocks get little attention from mainstream media. This is an advantage for investors because these stocks may be improperly underpriced. Thus, investors have chances of reaping huge returns from such inefficiencies.
Cons of Small Cap Investments
Apart from all the pros, small cap investments also have cons. Two major cons are:
- Risk: In small cap business, risk is a big factor thwarting investments. Small cap companies have small customer bases. Therefore, their prospects tend to be rather uncertain and pinned to specific regional areas. Also, due to their small size, such companies are also subject to market volatility.
- Time: When it comes to small cap stocks, time is a constraint. Clearly, small cap companies take time to grow to a level where there can be huge returns on investment.
Final Word
Small capitalized investments do have considerable amount of risk. But, they can also be quite profitable over the course of time. So, before making any such investment, it is advisable to consider all the factors involved.