What Are Small-Cap Stocks?

dolphinCapitalization refers to the value of a company. To find the capitalization, simply take the price of the stock and multiply it by the number of shares. In general stocks are divided up into three classes: small-caps, mid-caps and large-caps. While I’m sure there are probably specific dividing lines that someone has created to separate small, from mid, from large caps, those lines are really arbitrary and will obviously change over time due to inflation and due to companies getting much bigger. The important thing to know is just that small- caps are relatively new companies with a lot of room to grow, while large-caps are well established companies with many product lines. Mid-caps fall somewhere in between. There are even micro-caps, which are really small companies, perhaps being run out of someone’s garage.

Small-cap stocks are by nature growth stocks since they are just finding out what works and growing their product lines. They are also more risky than large-caps because they do not have a cash reserve to fall back on or the ability to sell off assets should they make a misstep. They can also be put out-of-business by a downturn in the economy even if they are doing everything right because they don’t have the ability to wait for things to turn around.

Still, because they are small, small-caps have the ability to grow their earnings much more rapidly than a large-cap. A company that does a billion dollars in sales and sells to pretty much everyone would have a hard time doubling their sales. A small company with four restaurants can double their sales simply by adding another four restaurants. Because stock price follows earnings, there is the potential to make a lot more money over long periods of time by investing in small caps than you will if you stick to the blue chip companies.

To find small-cap stocks, look for companies that are in limited regions of the country. These may very well be companies of which you have never heard. You may therefore need to go through a stock research publication, such as the Value Line Investment Survey to find them. You might also find a business you really like while traveling, or read about a company with a new product that sounds good in a magazine or newspaper. Be careful, however, since just because a company has a good product doesn’t mean they’ll be successful at running a business to sell it.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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