What are Small Cap Stocks?
The term refers to stocks with a small market capitalization, between US $250 million and $2 billion. Stocks with a market cap below $250 million are referred to as Micro Caps, and those below $50 million are called Nano Caps. Small Cap stocks can trade on any exchange although a majority of them are found on the Nasdaq or the OTCBB because of more lenient listing requirements. It is important to make the distinction between Small Caps and Penny Stocks. You can be a Small Cap without being a Penny Stock. There are plenty of Small Caps trading at more than $1 per share, with more liquidity than the average Penny Stock.
Why Should I invest in them?
Small Cap stocks have a bad reputation. The media usually focuses on the negative side of Small Caps, saying they are risky, frequently fraudulent and lacking in quality that investors should demand in a company. Certainly these are all valid concerns for any company, but in the wake of the Enron and Worldcom scandals, there is certainly an argument that company size is by no means the only factor when it comes to getting scammed.
The good news is, Small Caps are not as risky an investment when you have the right advice. And the best part is, Small Caps themselves can actually produce a higher percentage gain on your investment than most Large Caps. Why? Because Small Caps are just that, companies with small total values, they have the ability to grow in ways that are simply impossible for large companies. A large company, one with a market cap in the $1 billion to $2 billion range doesn't have the same potential to double in size as a company with a $500 million market cap.
To learn more about Small Caps and why you should invest, please see our About page.
What are the risks?
As with any investment venture, you are always taking a risk when investing in stocks. Those risks of course can be minimalized by the use of quality financial guides and advice, but they will still be there.
As far as Small Caps go, often times much of their worth is based on their propensity to generate cash, but they have yet to scale their business model. This is where much of the risk comes in. Not many companies can replicate what U.S. retail giant Wal-Mart has done, expanding from essentially a mom-and-pop store in Arkansas to a nation-wide chain with thousands of locations. Small Caps are also more susceptible to volatility, simply due to their size - it takes less volume to move prices. It's common for a Small Cap to fluctuate 5% or more in a single trading day, something some investors simply cannot stomach.
While yes, this does create risk. This also creates a large potential for solid gains.
Do Mutual Funds invest in Small Caps ?
Generally, no, most Mutual Funds don't invest in them. It isn't uncommon for Mutual Funds to invest hundreds of millions of dollars in one company. Most Small Caps don't have the market cap to support this size of investment. In order to buy a position large enough to make a difference to their fund's performance, a fund manager would have to buy 20% or more of the company. The SEC places heavy regulations on Mutual Funds that make it difficult for funds to establish positions of this size. This gives an advantage to individual investors who have the ability to spot promising companies and get in before the institutional investors do.
Investing Questions
Where is the best place to buy/trade stocks?
You can buy and trade Small Cap stocks through most brokers; however, we generally do not recommend any specific brokers. You should do as much research as possible though, and try to find a broker that you are comfortable with.
When investing, how much should I invest?
Despite the fact that Small Caps demonstrate attractive characteristics, there is a flip side. The money you invest in Small Caps should be money you can expose to a much higher degree of risk than that of proven cash-generating machines like Large Caps and Blue Chips. The actual amount of money you invest though is entirely up to your level of capability, and should be done so on a discretionary basis (i.e. if you need your car to get to work, then don't invest the car).
Where can I find definitions of financial terms and meanings?
One of the best places on the Internet to find meanings and definitions of financial terms is Investopedia.com.
