Making the Most of Small Cap Investments

Investing in the stock market is a bit risky, but it can be a great way to earn additional income and diversify your asset portfolio. Small-cap investments can be particularly profitable. Keep reading to learn a bit more about the role of market capitalization, the benefits of small-cap investments, and how to find promising small-cap companies.

What Is Market Capitalization?

A company's market capitalization refers to the total market value of its outstanding shares, or how much it would cost to purchase every company share at the current market price. This number is calculated by multiplying a share's current market price by the company's number of outstanding shares.

Companies are broken up into four major categories based on their market cap:

  • Micro-cap: These companies have a market cap as high as $300 million. Market caps this small generally indicate a company that has only been in business for a short while, operates in a small niche of the market, or has an unpredictable cash flow.
  • Small-cap: Though only slightly more established than micro-caps, small-caps have a market capitalization between $300 million and $2 billion.
  • Mid-cap: With a market cap of $2 billion to $10 billion, mid-caps and/or their industry are usually in the expansion process.
  • Large-cap: Companies that are large and well-established typically have a market cap of $10 billion or more.

Why Should I Invest in Small-Cap Companies?

Making the Most of Small Cap Investments

Because of the new and often unpredictable nature of small-cap stocks, they are considered a bit riskier than their more established counterparts. The very same characteristics that make them higher-risk also make them incredible investment opportunities. This is because small-cap stocks:

  • Have great potential for growth. Small-cap companies have almost unlimited potential for expansion and growth, meaning there is a much higher chance that you could get a significant return on your initial investment.
  • Discourage large institutions. In order for large mutual funds to invest enough in a small-cap company to impact the institution, they'd have to purchase more than 20% of the shares. The SEC regulates mutual funds pretty stringently, discouraging them from making investments this large. As a result, individual investors are able to recognize and invest in a promising company before institutions have a chance.
  • Are overlooked by Wall Street. Wall Street often disregards and undervalues small-cap value stocks, making it possible for you to make a much higher profit.

How Can I Find the Best Small-Cap Companies?

There are several things you can do to identify the best small-cap companies, such as:

  • Invest in companies without debt. Companies with little to no debt are usually able to successfully weather tough times in the future.
  • Evaluate the dividends. Look for small-cap stocks that pay 2% dividends or more.
  • Focus on resilient industries. Some industries are more affected by a rise in interest rates than others. By investing in essential industries, you can avoid potential impacts.

Before you get started buying and selling small-cap stocks, it's important to research the market and the most effective investment strategies to ensure you're successful. Once you do this, you can minimize the risks and enjoy the rewards.