Small-Cap Investing in a Bear Market

While the definition of a small-cap stock can vary, it is generally considered to be a company with market capitalization of $300 million and $2 billion. The appeal of small-cap stock investing is in the potential returns they offer. While the larger-caps and thoroughly followed and reported on by Wall Street analysts, small-caps tend to fly under the radar, often leading to inefficient pricing of these stocks. Additionally, smaller-caps may have greater upside potential than the larger-caps, which can lead to tremendous returns. Small-cap stocks can provide an even greater investment opportunity during an economic downturn, for investors who are willing to accept the risk.

The risks associated with stock market investing can be significant, regardless of the market-cap of the stocks you choose. Small-cap stocks are considered to be among the highest-risk choices for stock investors, though, because they are typically more susceptible to competitive pressures and changing market conditions. Add to that the fact that the company management team has not yet proven its merit. Additionally, many small companies lack historical data on which to base an investment decision, which can make them more of a gamble than an investor might like.

That said, smaller companies can be more adaptive and responsive to emerging opportunities than their larger counterparts. They also have a greater opportunity for rapid growth as it is easier for a smaller company to double its sales volume.

With fewer resources, smaller cap stocks can be more vulnerable during economic downturns, leading to a tendency of investors to seek the relative shelter of treasury bills and “blue chip” types of stock investments. For many of these smaller stocks, this kind of exodus can lead to an “over-sold” situation and a significant value opportunity. In volatile markets, like today’s, small-caps can be discounted disproportionately to the rest of the market. In seeking out those small-cap stocks that offer your best chance for strong returns, you should stick with industries you know and choose those companies that look to have positioned themselves for future success. It is best if the company is holding significant cash reserves and minimal debt.

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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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