Small-cap stocks seem to be holding a lot of interesting possibilities in the wake of the prevailing market conditions. Several industry veterans have expressed their interest in these, considering them promising investments.
However, if you’re just venturing into the field of small-cap stocks, there are several important things to keep in mind which this article aims to familiarize you with.
Understanding Small-cap Stocks
The first is understanding what small-cap stocks are and how they function. Things are not as well-defined as it might seem, though. The categorization of companies as small, mid, and large-cap is highly subjective and varies greatly among the market analysts.
It is important to first understand what market capitalization is and the mechanism of measuring the same. The market cap is measured using the number of shares that are outstanding multiplied by the current price of the share. Once you determine the market capitalization, you can easily categorize firms. Small-cap stocks are stocks of publicly traded companies with market capitalization varying from about $300M to roughly $2B.
It is also imperative to understand the difference between small-cap and penny stocks. Most small-caps are actually penny stocks. Penny stocks are generally thought of at being valued under $1, but the SEC defines penny stocks as being valued under $5. Small-cap stocks generally have a higher liquidity as compared to most penny stocks.
Benefits of Small-cap Stock Investments
First and foremost, investors find it extremely difficult to trace valuable information about small-cap stocks when compared with large-cap companies. There is a high probability of these small-cap stocks having inappropriate pricing which results in the creation of some very powerful opportunities for the investor who can expect to earn high returns.
Hedge and mutual funds, as well as other financial institutions, cannot heavily invest in small-cap firms because of the probability the stock price will be pushed through artificial means.
Furthermore, small-cap firms have a lot of room to grow when compared to the large-cap companies.
Know the Risks
It is of critical importance to understand the risks associated with investing in small-cap companies. For starters, small-cap stocks show lower liquidity when compared to their mid or large-cap counterparts. This means you could experience greater risks with them.
To protect your investment, thorough research is recommended to investigate the reliability of the business model. It’s also important to vet the experience and integrity of the company management.
Considering small-cap stocks sometimes swing wildly in price, especially after press releases, it’s important to have stop losses, pre-programmed sales, or alerts set up for your portfolio if you aren’t an active day trader.