As investors, sometimes we get bogged down in what we could have invested a month ago, a year ago, and beyond.
It’s easy to trap yourself in the mindset of “if I would have invested in Apple back in this year I’d be filthy rich.”
The truth is, you can’t turn back time—but you can look forward and catch the next big fish while it’s still a minnow.
And that’s exactly what investing in small-cap stocks is all about.
Typically, small-cap stocks represent companies with a market capitalization between $300 million and $2 billion.
Investing in small caps gives you the advantage of placing a marginal investment that holds the major potential to grow in value.
Small-caps often outperform large-cap companies.
However, small caps are prone to busts, which means they come with higher risk.
You’re probably wondering how big can a small-cap get, and is it worth your time and money to invest in one.
Let’s take a look at how big small-caps can get and why small-cap stocks can be a great investment for you.
Characteristics of a Small-Cap Company
Despite the name, small-cap companies do not occupy the lowest market capitalization range.
Below small-caps are micro-cap companies, which represent companies with a market capitalization of $50 million and $300 million.
Yet, small caps are much like micro caps in that they are usually newer or start-up companies looking for investors.
The goal of these companies is the same as any other: grow and generate profit.
But that’s not necessarily the only path they can follow.
For some start-ups, their goal is to reach a point where they’re absorbed or bought out by one of the large companies.
Does that make them worth investing in? Yes.
If the small-cap you’ve invested in grows to double the size, then you’ve made a great investment.
But, if they sell out, you still get a nice payout.
On the other hand, small-caps are prone to volatility.
It’s much harder for a small-cap company to recover from market changes or recessions.
Since these companies are typically start-ups, they’re not likely to be financially stable to begin with.
Suffice to say, small-cap investing is inherently high-risk, high reward.
3 Advantages of Investing in Small-Caps
Understanding what makes a small-cap company worth investing in can help you navigate the market. It can also help you avoid beginner mistakes, such as not doing enough research. Below are three major advantages of investing in small-caps,
1. Growth Potential
Whether you’re an investor making their first investment or you’ve been doing it for a while, you shouldn’t pass up on small-caps.
Within the small-cap market are thousands of companies that offer marginal investment opportunities.
While many of these companies won’t pan out, you could—with the right information—find a company that’s on a path to major growth.
After all, it’s much easier for a start-up to double in size than a well-established company.
Just so, it’s much easier for a small-cap to collapse than a well-established company as well.
But that’s why researching is key.
2. Under the Radar
Because small-cap companies aren’t big names with extensive financial history and viability, they’re often overlooked.
You’re unlikely to see major financial analysts talking about small caps on TV, nor are you likely to come across a plethora of reports on them.
But their neglect can be your advantage.
Often small-caps are underpriced simply because they haven’t garnered the attention of larger companies.
With less competition in the small-cap market, you stand to gain more.
You don’t have to worry about a big-time investor like Warren Buffet gobbling up shares.
It’s an excellent opportunity to see what’s out there before other savvy investors find it first.
3. Growth Under Recovery
While small-caps have a hard time surviving recessions, periods of economic recovery can be great for them.
During recovery efforts, interest rates are low.
Low-interest rates allow small-cap companies to access funds that they could use to continue growing and developing.
A small-cap company that survives economic turmoil might be a sign of strong management.
It’s also a sign that they may be worth investing in.
How To Research a Small-Cap Company
Reliable information on small-caps isn’t easy to come by. Even harder for some is to know what to look for in the first place. Below are several key things you should look for before investing in any small-cap company.
1. Market Conditions
One of the first things you need to look at is what kind of market is the small-cap in. Like other companies, small-caps are vulnerable to market cycles and economic conditions.
If the economy is going through a rough patch, you may want to hold off on investing in small-caps because they’re less likely to have the finances to weather the storm.
But in times of economic boom or recovery, small-caps benefit the most, making it an ideal time to invest.
It’s also worth mentioning that small-caps are much more likely to be affected by local markets than larger companies who are often affected by global conditions.
2. Paradigm Shifts
When new market opportunities arise, small-cap companies can take advantage by specializing in a specific field or service.
For example, several nations, including China, the US, and the EU, have made efforts to end fossil fuel reliance and replace it with electric vehicles (EVs).
But to produce enough batteries and parts for EVs requires significantly more amounts of copper.
So companies that mine for copper and other metals can be a great small-cap investment opportunity.
3. Check Their History
Although small-caps tend to be newer companies without an extensive history, there are still things you can look for.
One major key metric is debt.
Any company with large amounts of debt, small-cap or not, is almost certainly not a good investment.
Check their balance sheets to ensure they aren’t taking on more debt than they can handle.
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