What are Small Cap Stocks?

Key Points

• Small Cap stocks have a market cap below $2 billion and are often included in equity growth portfolios.
• Historically, over longer periods of time, small cap stocks outperform large cap stocks as they have a greater ability to grow given their size (once you get to a certain level of revenue it becomes harder to grow)
• There is always a trade-off between risk and return and small cap investing is no different. There exists greater return potential, but also greater risks given the upstart nature of these businesses.
• For those reasons it is important to do solid research on these companies or outsource to someone you trust (i.e. a mutual fund or ETF). However we aim to find great small companies here at Genvest to include in our portfolios. 

The Smaller One on the Block but is Showing BIG Potential

A small-cap stock is a company whose market capitalization is between $300 million and $2 billion. These companies are smaller in market value than both mid-cap companies and large-cap companies but will often still be included in the investment strategy for an equity growth portfolio. 

Small-cap stocks will hold more risk than mid-cap stocks and large-cap stocks but similar to mid-cap stocks have the potential for higher growth. 

Historically, small-cap and mid-cap have outperformed large-cap which is most evident in the early expansion stages of the cycle. This is often because smaller firms might be specialized in an innovative fashion allowing them to be quicker with the deployment of their capital in order to keep gaining market share at a rapid rate. 

Some refer to this as the Small Firm Effect. 

Investors Need to Research and Have HIGH RISK Tolerance

While small-cap stocks are attractive because of their potential growth which can reward investors with above average returns, the higher level of risk should be taken into account when it comes to an investor’s tolerance. 

Small-cap companies are not as heavily covered by equity research analysts which can make them time consuming to actively research. 

Due to their risky nature, small-cap stocks can be subject to higher levels of volatility for several years. They will also not have as strong of a balance sheet to withstand economic downturns like a large-cap company or potentially even the FCF(Free Cash Flow) to meet debt obligations. 

Having small-cap names in a growth portfolio is a common investment strategy but sometimes it is best to research and invest in a small-cap fund with a proven track record of success.