A Guide to Small-Cap Investing

Small-cap investing focuses on firms that have smaller market caps than most stocks.

While small caps have well-known risks, they also provide significant benefits that many investors do not realize.

Small-cap stocks are your opportunity to potentially “beat the market” and enjoy a much better return on your investment than if you invested in larger companies.

What Are Small-cap Stocks?

Small-cap stocks are tradeable shares available in a given market. Some investors consider small-cap stocks to have a market cap of up to $2 billion. 

While you might be sitting there thinking a company with a market cap of $2 billion is still pretty big, when you consider the world’s most significant market caps are at least 100 times that and often even higher, you get a better idea of small-cap stocks in context.

Small-cap stocks don’t get much mainstream media coverage, so you’re unlikely to find household name brands or companies you have seen as investment tips in the news when looking for these investments.

The Pros and Cons of Investing in Small-cap Stocks

There are several reasons why investing in small-cap stocks can be beneficial. Still, it pays to be aware of the potential downsides.

What are the Benefits of Investing in Small-cap Stocks?

They’re a cheaper investment. You don’t need much money to start investing in small-cap stocks. By contrast, you might need thousands of dollars to buy a single share in larger companies.

You have more scope for growth. As you start from a lower base, small-cap stocks have far more potential to grow and increase your investment value.

Small-cap stocks are often uncompetitive in terms of the number of people wanting to buy them. Large investment houses often don't focus on them for various reasons. You will find it easy to buy small-cap stocks as an individual investor.

Small-cap stocks are often underpriced due to the lack of coverage they get. As well as being able to take advantage of a lack of competition, small-cap stocks may be even cheaper than they should be. This gives you a fantastic opportunity to get even more value from your investment!

The Potential Downsides of Investing in Small-cap Stocks

A higher volatility means you must be prepared to hold small-cap stocks for an extended time and not be put off by vast swings in either direction — with the volatility being similar to crypto’s winter. Of course, you may profit if you sell at a high price.

Limited liquidity of the small-cap market. Despite small-cap stocks growing in popularity with retail investors, market liquidity sometimes remains limited. Your ability to sell small-cap stocks on the upswing might also be limited, making it even more critical that you’re comfortable holding potentially volatile stocks.

Reduced transparency about small-cap companies. Finding out what’s happening at Amazon or Apple is easy; they are in the news daily. However, it can be tougher to find relevant information about small-cap companies and, thus, more challenging to decide whether you should invest.

How Do You Know Which Small-cap Companies to Invest in?

Not getting away from the fact that small-cap investing carries an element of risk. But then, so does any other investment.

You may need to rely on some intuition when investing in small-cap companies. For example, if you can find out about the business's leadership or long-term plans, there isn't a metric that tells you whether these are good or bad.

However, you should find it easier to find financial data about a business that will remove friction from your decision-making process.

Look for data around:

• Earnings and revenue. Many small-cap businesses may not be profitable yet. However, you can take this as a positive sign if they see consistently growing revenue.

• Earnings per share. If a company is profitable, its earnings per share can indicate how investable a business is.

• The price-to-earnings ratio. This can help you calculate whether a stock is a good value. Lower ratios indicate potentially underpriced stocks and good investment opportunities.

Summing up

It is possible to succeed in small-cap investing, but you must ensure you do your homework. Consider whether you’re comfortable with the potential pros and cons of small-cap investing, and find those small-cap companies that offer the best investment value and potential long-term growth.

Disclaimer: This article is for informational purposes only and does not constitute a recommendation or investment advice. You should not construe any such information or other material as legal, tax, investment, trading, financial, or other advice. Please seek a professional financial advisor before making any investment decision. We are not responsible for and do not endorse or accept any responsibility for the availability, contents, products, services or use of any third party website as stated in our privacy policy.