Small-Cap definition and investing
Market capitalization refers to the value of all outstanding shares of a corporation or company. It is calculated by multiplying the company’s current share price by the number of outstanding shares in the market. Investors would often consider market cap to manage the risk and return of their trades since it has a relationship with them. In this article we are going to define small-cap companies and explain the advantages and disadvantages of investing in their stocks.
Small-cap the abbreviated form of small-capitalization refers to companies with relatively small market capitalization while the market capitalization of any particular corporation is calculated based on the market value of its outstanding shares. Generally a company that has a market capitalization between $300 million and $2 billion is considered small-cap.
Investing in small-cap stocks would offer the investors the chance to beat institutional investors and have an advantage over the big fund managers. Small-cap companies are popular for their huge growth potential. However some believe that there are lots of risks associated with such companies since their market is volatile. So in case, you have the patience to wait for gains in the long-term and you are ready to accept the risks for higher profit potential investing in such companies is best suited for you. Small-cap stocks can be traded on any exchange or broker while the majority of them are found on the Nasdaq.
Advantages and disadvantages of small-cap investing
As mentioned earlier the most important advantage of investing in small companies is the potential growth they offer. It is not ignorable that all large companies with big capitalization were once small. These small companies would often focus on bringing new products and services, so they have the chance to grow significantly and even build a new market. Remember that Apple is not going to be the next Apple since it cannot grow so fast bigger than the entire economy. Another important advantage of investing in small companies is that large mutual funds do not invest in them. Big mutual funds often invest large amounts of money in one company while small caps do not have the market capitalization to support such large investments.
There are of course some drawbacks too. Since Small-cap companies often have much smaller customer bases, there are some risks and uncertainty associated with investing in them. They are often tied to a specific geographical area so their stocks may not be able to survive through rough times caused by different factors in the economy. On the other hand, for these stocks even small trading volume may cause high volatility. It is common for the prices to fluctuate 5% or more during a trading day. Considering the fact that these stocks often have less liquidity resulting in more difficulty to exit a position in the market many investors are not interested in investing in them.
Another important disadvantage of small-cap investment is that it may take investors a long time to find proper companies since there are no growth rates as it is available with large companies. Investors should often rely on some analyst reports and do their own research to find the right stock to invest.
Small-cap vs mid-cap companies
Some investors may consider mid-cap companies to overcome some of the disadvantages of small companies invest. These corporations as mentioned earlier have market capitalizations between $2 billion and $10 billion. Based on the reports and analysis, these companies have more stability in comparison with companies with small capitalization while they still offer the chance of significant growth rather than large companies with high capitalization.
Top small-cap stocks analysts love
- Unisys Corp. (IT consulting services)
- XBiotech (a biopharmaceutical company)
- Northern Oil & Gas (acquisition, exploration, development, and production of crude oil and natural gas properties)
- TRI Pointe Group Inc. (homebuilding company)
- Magellan Health Inc. (manages the delivery of behavioral health care treatment services)
- PJT Partners Inc. (global advisory banking firm)
- ChemoCentryx Inc. (a biopharmaceutical company)
- Inovio Pharmaceuticals Inc. (drug manufacturer)
- Novavax Inc. (clinical stage biotechnology company)
Frequent questions and answers
A small-cap company refers to a corporation with a market capitalization of between $300 million and $2 billion. The classification is not exact.
Small-cap stocks offer investors the chance to grow significantly with a low amount of initial capital. Investing in companies with small capitalization is suitable for those who are interested in growth investing and have patience and are able to accept risks with the aim of higher gains.
Small-cap companies are considered riskier investments rather than large-cap companies for several reasons. Although they offer greater growth potential over the long-term, they are more vulnerable to negative events and bearish sentiments in the market while the volatility associated with these stocks is often high.
Generally, large corporations have market capitalizations of US$10 billion and greater, while mid-cap companies’ market capitalization is around $2 billion and $10 billion and small-cap companies have a market capitalization of $300 million to $2 billion. Large companies often tend to grow slowly in comparison with small and mid-cap corporations. It is important to note that these classifications such as small, large, and mid-capitalization may change over time and vary between brokers so there is no exact definition and classification. The major advantage of investing in small companies stocks is the significant growth potential that is not offered by larger companies. However there are some drawbacks including higher risk, higher volatility, and low liquidity.