Small-Cap Stocks: Everything You Need to Know About Them

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Some of the best investments started off as small-cap stocks, which are companies with a market cap between $250 million and $2 billion. Not every small-cap company turns into a giant like Amazon or Apple, but investing in smaller companies can be pretty rewarding since they have more growth potential compared to bigger companies. If you're interested in the best stock investments and thinking about small-cap stocks, here's a guide to help you out.

Importance of Market Capitalization

Market cap measures how big a company is. It's the total value of all a company's outstanding shares, including both publicly traded shares and those held by insiders. To figure out the market cap, you just multiply the number of shares by the current share price. For example, if a company has 10 million shares and they're trading at $20 each, the market cap is $200 million. Market cap is important because it gives you an idea of where a company is in its growth journey. Newer public companies with smaller market caps might have more growth potential. It also hints at a company's stability: Large-cap companies are usually less volatile than mid or small-cap companies.

When it comes to small-cap stock indexes, there are two main ones to know about:

• The S&P SmallCap 600, which includes 600 stocks with market caps from $750 million to $4.6 billion, making up about 3% of the U.S. market.
• The Russell 2000 Index, which covers the 2,000 smallest stocks in the Russell 3000 Index.

Steps to Invest in Small-Cap Stocks

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If you think small-cap stocks are your jam to make money in stocks, you can buy and sell shares of individual companies right through an online broker like TradeStation. If picking individual stocks feels too risky or like too much work, you can go for small-cap focused ETFs and mutual funds like iShares Russell 2000 ETF (IWM), Fidelity Small Cap Growth Fund (FCPGX), or Vanguard Small-Cap Value Index ETF (VBR). Just remember, there's less analyst info on small-cap stocks compared to the big guys. If you don't have the time, interest, or know-how to make your own moves, think about getting a financial advisor or using a robo-advisor.

Benefits and Drawbacks of Small-Cap Stocks

Small-cap stocks can grow a lot, but make sure to weigh the good and the bad before diving in.

Benefits

• Lots of different companies, from start-ups to established businesses.
• Less competition from big institutional investors.
• Lower share prices can make it easier to start investing.
• Bigger growth potential than mid to large-cap companies.

Drawbacks

• Limited research is available since financial institutions and analysts usually focus on bigger companies.
• Less liquidity means it can be hard to sell quickly at good prices.
• Volatile prices can be tough for some investors to handle.
• Higher risk since they're more sensitive to market changes.

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Small-Cap vs. Penny

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Penny stocks are those cheap shares (under $5) that usually trade over the counter (OTC) via pink sheets instead of on a regular exchange. Technically, since they have low market caps, they fall under small-cap stocks, or more specifically, micro-caps. But penny stocks are way riskier because they lack liquidity, have wide bid-ask spreads, and often represent unprofitable companies. Some are even scams, like pump and dump schemes where scammers hype up the price and then sell off at inflated prices.

Small-Cap vs. Mid-Cap

Mid-caps are generally established companies in industries seeing or expecting significant growth. With market caps between $2 billion and $10 billion, mid-caps are less volatile and risky than small-caps but offer more growth potential than large-caps. So, mid-cap stocks can be a solid choice for investors looking for a mix of moderate growth potential and moderate risk.

Small-Cap vs. Large-Cap

Large-cap companies, with market caps of $10 billion or more, are mature, well-known companies that are big players in their industries. They might not grow aggressively anymore, but they offer stability and often pay consistent dividends. On the other hand, small-caps have historically outperformed large-caps and are more likely to see rapid revenue and profit growth. However, this potential for growth comes with more volatility and sensitivity to macroeconomic changes, which can be a bit too much for risk-averse investors.

Similar Reads You May Enjoy: Top Long-Term Investments for 2024: A Comprehensive Guide

Conclusion

Small-cap stocks can really grow a lot compared to big companies since those big guys aren't growing as fast anymore. But remember, with big potential rewards come big risks. Everyone dreams of finding the next Amazon or Google early, but small-cap stocks are riskier because these companies are newer, less proven, and might not have as much money to work with, making their stock prices jump around more. They're great for folks who don't mind taking on extra risk for the chance of bigger gains. And like with any investment, make sure you do your homework before diving in. If you're not up for picking stocks yourself, you might want to think about getting some help from a financial advisor or a robo-advisor.

FAQ

Do small-cap stocks perform well during periods of high inflation?

Yeah, smaller companies might handle high inflation and rising interest rates better than you'd think. Historically, U.S. small-cap companies tend to outperform larger ones when inflation and rates go up. Plus, they've often led the market recovery after a recession and outperformed bigger companies over several years. Some experts reckon small caps might do better because they can adapt more quickly, like by raising prices or finding new supply sources.

Do small-cap stocks perform well in recession periods?

Over almost 40 years, including several recessions like the 2007/2008 global downturn, small-cap stocks had an annualized net total return of 9.9% during "recession and recovery" periods. In comparison, large-cap stocks had average returns of 4.9% during the same times. But, of course, remember that past performance doesn't guarantee future results.

This content was created by AI