Overview of Small Cap Stocks
Before we write about small cap stocks it is important to understand what the term means. Companies are
usually broken down into sizes based on their capitalized values. This value is determined by multiplying
the number of shares of the company by the current market value of those shares as determined on the
relevant stock exchange. For example, if we have a company with 100,000,000 shares outstanding and the
stock id trading at $9.00 per share then the capitalized value is $900,000,000 ($9.00 per share X
100,000,000 shares). In the investment world a small cap stock is generally considered to be a company with
a capitalization of less than $1,000,000,000 (one billion dollars).
When investing your money there are endless types of you can purchase. Small cap stocks are just one of
those choices. Your investment objectives will determine the investments you need to hold in your portfolio.
For the growth portion of your investment portfolio small cap stocks are an excellent addition. Small cap
stocks have shown a better rate of return over the long haul than large cap stocks (your well know
Microsoft's and Wal-Mart's). For $1 invested in the 1920's, small cap stocks have returned $2,843 by the
1990's whereas large cap stocks have returned $811 (source:Investing in Small-Cap Stocks, Christopher
Graja, Elizabeth Unger PhD; Bloomberg press). The risks are higher but the rewards are greater.
However, as with most investments it will be better to have a diverse mixture of small cap stocks. In this
way the winners we more than make up for the losers.
We have given you a brief overview of small cap stocks. Now we will give you some of the reasons why
small cap stocks generally outperform the better known large cap stocks.
Basic economics tells us with the supply/demand curve as demand increase and supply stays the same then
the price of the item will generally increase until equilibrium has been reached. This theory is one of the
reasons to invest in small cap stocks. In the world of investing the big players, and investment firms usually
cannot invest in the small cap stock since there are not enough shares trading in the quantities that they
generally purchase. Over time the successful small cap stocks start to grow and they reach a point where
they become large enough for the big players to start purchasing. This is where the supply/demand theory
kicks in. The large purchases made by mutual funds and brokerage house push up the demand for a stock
while the number of shares available is limited, thus pushing the price up.
Another reason to invest in small cap stocks is related to their exposure to the investment community.
Brokerage houses and investment firms are recommending shares in companies to their clients all the time.
To do this they carry out extensive research on the companies they might want to recommend to their
clients. However for this to be profitable for the brokerage firm the recommendation must have enough
shares trading for the client to buy sufficient quantities to generate large commissions.This underexposure
presents opportunities to the individual investor of finding good quality companies with little or no
exposure. Because they are small and not complicated the small cap stock is easier for the individual to
analyze
As with all investment portfolios there is a need to have a diversified collection of different types of
investments. Someone who is young has many years of investing ahead of them and therefore can take a
more aggressive approach to investing. The small cap stock would fit the aggressive portion of the portfolio.
It will have time to grow and if there is a loss the young investor has time to recover the loss.
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