Are you ready to uncover the secret behind some of the most successful investments? Let me introduce you to small-cap stocks – those hidden gems that have the power to turn your fortunes around. While not every small-cap company will become the next Amazon or Apple, investing in these small companies can be incredibly rewarding. They offer a unique opportunity for explosive growth that larger companies can’t match. If you’re curious about exploring the world of small-cap stocks, then this essential guide is just what you need.
Why does market capitalization matter?
Market capitalization, often referred to as market cap, is a crucial factor to consider when evaluating a company. It measures the company’s size by calculating the total value of its outstanding stock shares. Small-cap stocks typically have a market capitalization between $250 million and $2 billion.
Market cap provides valuable insights into a company’s development and stability. Smaller market cap companies often have more room for growth, while larger companies tend to be more stable. By understanding a company’s market cap, you can make informed investment decisions.
Small-cap stocks vs. large-cap stocks
Large-cap companies, with market caps of over $10 billion, are well-established players in their industries. While they offer stability and may provide consistent dividends, their potential for aggressive growth is limited. On the other hand, small-cap stocks have historically outperformed their larger counterparts. They tend to experience rapid revenue and profit growth, making them enticing investments. However, keep in mind that small-cap stocks are more volatile and sensitive to market changes.
Small-cap stocks vs. mid-cap stocks
Mid-cap stocks offer a balance between small-cap and large-cap stocks. These companies, with market caps between $2 billion and $10 billion, are usually established players in growing industries. They offer less volatility and risk compared to small-cap stocks while still providing growth potential.
Small-cap stocks vs. penny stocks
Penny stocks, with share prices under $5, fall under the small-cap category. However, they are riskier investments due to their lack of liquidity and the potential for fraudulent activities. Penny stocks are generally associated with pump and dump schemes, where scammers manipulate prices for personal gain. It’s important to exercise caution when considering penny stocks and conduct thorough research.
Small-cap stocks and asset allocation
When it comes to allocating your investment portfolio, your risk tolerance and investment goals play a vital role. The American Association of Individual Investors (AAII) suggests specific allocation breakdowns based on risk tolerance. As an investor, it’s crucial to evaluate your comfort level with risk and balance your investments accordingly.
Advantages and disadvantages of small-cap stocks
Small-cap stocks come with their own set of advantages and disadvantages. Let’s take a closer look at what makes them unique.
Pros:
- Higher growth potential compared to mid- to large-cap companies.
- Lower share prices make initial investments more accessible.
- Less competition from institutional investors.
- Diverse range of companies, from start-ups to established businesses.
Cons:
- Higher risk due to sensitivity to market changes.
- Volatile prices may be challenging for risk-averse investors.
- Less liquidity, making it difficult to sell shares quickly at favorable prices.
- Limited research availability compared to larger companies.
How to invest in small-cap stocks
If you’ve decided to venture into the world of small-cap stocks, there are a few ways to get started. You can buy and sell shares of individual small-cap companies through online brokers like TradeStation. However, if you prefer a more diversified approach, consider investing in small-cap focused exchange-traded funds (ETFs) and mutual funds. Examples include iShares Russell 2000 ETF (IWM), Fidelity Small Cap Growth Fund (FCPGX), or Vanguard Small-Cap Value Index ETF (VBR).
While researching individual small-cap stocks can be time-consuming, it’s worth the effort. However, if you lack the time or expertise, you can work with a financial advisor or robo-advisor services like M1 Finance to guide your investment decisions.
Small-cap stock indexes
Two prominent indexes serve as benchmarks for the small-cap equities market:
- The Russell 2000 Index includes the 2,000 smallest stocks in the Russell 3000 Index.
- The S&P SmallCap 600 consists of 600 stocks with market caps ranging from $750 million to $4.6 billion, representing 3% of the U.S. market.
Best small-cap stocks based on one-year performance
To help you kickstart your investment journey, we’ve compiled a list of the top 10 small-cap stocks based on their one-year performance. Take a look at the TradeStation Radar Screen image below for a glimpse of these high-performing stocks:
Image courtesy of PowerZone Trading
TIME Stamp: Small-cap stocks have both growth potential and higher risk
Small-cap stocks offer something that larger companies can’t – unparalleled growth potential. While large-cap companies have already experienced their explosive growth, small-cap stocks are just beginning their ascent. However, it’s important to remember that higher rewards come with higher risks. Small-cap stocks are riskier due to their shorter track records, limited access to capital, and increased price volatility. As an investor, you need to be comfortable with taking on this risk for the potential for greater rewards.
Frequently asked questions (FAQs)
Do small-cap stocks perform well during a recession?
According to research from Schroders, small-cap stocks have seen strong performance during recession and recovery periods. Over the years, small-cap stocks have outperformed large-cap stocks, providing an average net total return of 9.9% during these periods.
Do small-cap stocks do well during high inflation?
During periods of high inflation and rising interest rates, small-cap stocks have often outperformed their larger counterparts. Smaller companies have shown resilience in challenging economic environments and have the flexibility to adapt to changing conditions.
Will small-cap stocks perform well in 2023?
In 2023, the Russell 2000 has seen a 6.21% increase year-to-date, while the Russell 1000 and Russell Top 50 have experienced larger gains. While small-cap stocks had a slow start to the year, their performance is expected to improve as the possibility of a recession diminishes.
Investing in small-cap stocks can be a thrilling adventure with the potential for significant returns. However, it’s crucial to do thorough research and make informed decisions. If you need guidance, consider working with a financial advisor or reputable robo-advisor services to optimize your investment strategy.
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