Growth Investing and Small-Cap Stocks
Small-Cap stocks (stocks with small market capitalization) are generally defined as companies with a market capitalization of between $300 million and $2 billion (although the small-cap classification can vary among brokerage houses). While these securities trade with higher risk profiles than larger-caps, they can offer greater upside potential and may be appealing to investors who can tolerate the volatility.
The Appeal of Small-Cap Stocks
The most compelling thing about small-cap investing is the potential for higher growth rates than larger, more mature companies might offer. For the small-cap investor, the goal is in finding small, relatively unknown companies that are bound for greatness. As these companies grow and thrive, their stock prices can see tremendous increases.
While smaller companies often “fly under the radar” and escape widespread scrutiny they are typically nimble and able to react quickly to market changes and competitive pressures. Small companies tend to be able to exploit opportunities that larger companies can’t respond to in a timely fashion. Small-cap stocks often present growth investing opportunities due to their low valuations and potential to develop into larger cap stocks over time.
Investment Criteria
The criteria for finding small-cap winners can include:
• Strong Balance Sheet with significant cash reserves
• Solid expected earnings growth: many investors look for 30% or more
• A reasonable P/E ratio: many investors look for less than 20
• A debt-to-equity ratio of, ideally, less than .5
• Minimal analyst coverage
A Word of Caution for Small-Cap Investors
Small-cap investing does come with a number of cautions though as these stocks offer less liquidity than larger-caps. They are also more susceptible to economic downturns and the threat of competition from larger companies that may choose to compete with them.
Investors should also keep in mind that a small company’s growth rate can slow as the company gets larger or as its marketplace becomes more crowded. When this happens, investors can expect the stock price of the company’s stock to fall.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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