Small Caps
Candlefocus EditorSmall caps refer to publicly-traded stocks of companies with a market capitalization of between $300 million and $2 billion USD. Small-cap stocks are generally viewed as riskier than large-cap stocks due to their relatively small size, lack of well-known brand names and immature financials. However, investors seek to benefit from their growth potential and have seen higher returns in small-cap stocks compared to their large-cap counterparts.
History of Small Caps
Small-cap investments gained widespread popularity in the 1980s as investors embraced the potential for higher returns due to greater contact with smaller, innovative and potentially faster-growing companies. This growth has continued in recent years and small caps have become an increasingly attractive asset class for both individual and institutional investors alike.
Risks of Investing in Small Caps
Owing to their small size, small-cap stocks have become increasingly volatile and risky. They tend to experience greater fluctuations in market price, which often makes them unpredictable. Additionally, small-cap stocks may lack the liquidity of larger cap stocks as well as the financial wherewithal to be able to ride out short-term economic downturns.
In addition, small-cap stocks may be more susceptible to illiquidity, fraud and company failure. These factors, combined with the potential for high gains, can make investing in small-cap stocks a more risky, though potentially fruitful, endeavor.
Gains from Investing in Small Caps
Despite the risks associated with investing in small-cap stocks, they could potentially offer attractive gains to investors who manage to capitalize on their growth potential. Investing in small-caps could provide investors with the opportunity to reap high returns on a small initial capital.
They offer superior long-term capital appreciation when compared to large-cap stocks and enjoy greater upside potential due to their potential for rapid growth. Furthermore, since small caps are less popular than large-cap stocks, fund managers can benefit from information inefficiencies, thus allowing them to get in early on potential winners.
Bottom Line
Investing in small-cap stocks can be both risky and potentially lucrative. Investors should thoroughly research investments before investing in small-cap stocks, pay close attention to a company’s financials and consider the risks and opportunities that small-cap stocks offer.