Volatile and risky, you might be wondering why investing in small-cap stocks is worth considering. Granted, they are one of the riskier investments to add to your portfolio. But as the saying goes, with great risk comes great reward. The appeal of investing in small-cap is that you could be investing in the next big company. Trillion-dollar companies like Apple started out as small-cap companies with undervalued stocks; people that had invested in these companies when they were starting out have made impressive returns. Analyzing small-cap stocks takes time and dedication because of the risk they pose to investors. But if you know how to research small-cap stocks and play your cards right, you might just end up investing in the next Amazon. Read on to find out tips and tricks when it comes to investing in small-caps, including the one thing you should never overlook.
Getting Started: Bear or Bull Market?
One of the first things to do when getting started is to consider the market you are in. When it comes to small-cap stocks, it is best to invest in them during a young bull market. Small-caps usually outperform in economies that are growing and strengthening. If you notice you are in a bear market, characterized by declining prices or little growth in the stock market, then it is probably best to steer clear of investing in small-cap stocks.
Small-cap companies are usually in their expansion phase, which means that they do not have the same resources as large-cap companies. These resources play a pivotal part in whether a company will crumble under economic downturns or not. Small-cap stocks usually cannot weather economic hardships, such as those during a bear market, which is why investing in them in a bear market makes them even more of a risk than usual.
Delving Deeper: Market Shifts
Once you deem that the market you are in is conducive to small-cap growth, it is time to consider various paradigm shifts. These shifts in the market happen when a new need arises and there is a scarce solution for it. One instance of this is when, a couple of decades ago, there was a shift from CD to DVD format. Few people saw this shift coming, which means that few companies had the products/services to facilitate this shift. Those scattering of companies that did happen to provide the solution grew immensely because they had something that everyone needed. This is how small-cap companies grow and how their undervalued stock provides large returns. You do not see the same kind of growth in larger companies because they have already passed their expansion phase and are operating at near-maximum growth.
Market shifts can really impact the price per stock of small-cap companies, which is why it is important to be on the lookout for potential upcoming market shifts. Ways to do this are by analyzing different industries and staying in the loop regarding new developments. This might give you insight into an upcoming trend, which will then influence where you choose to invest in. Some industries to search for market shifts in are the medical industry, the cannabis industry, and the technology sector. If you happen to invest in a company that thrives under new trends, you could be making returns larger than you expected.
The 1 Thing To Never Miss: Looking at the Numbers
Small-cap investing has many nuances and requires a bit of work. One thing to never cut the corners on is looking at the numbers pertaining to your potential small-cap investment. Once you have looked at market type and searched for market shit opportunities, it is time to narrow down your small-cap choices.
To pick the small-cap, read all the resources available and really study the numbers—after all, the numbers don’t lie. Good indicators of future performance are past performance and earnings. Revenue growth over 20% is favorable and is a characteristic of a promising stock. Because they are in their expansion phase, small profit margins are typical of small-cap companies. So long as the revenue growth seems solid, profit margins are not something to deter you from investing. Other things to consider are:
Past price appreciation
Total addressable market
Because most small-cap companies are not well-known, there is little to no financial analyst coverage on them. This makes it harder to find statistics about the company you are trying to invest in. Still, small-cap companies tend to post their earnings reports, press releases, and growth projections on different internet platforms. The resources are there, you’ll just need a bit of elbow grease to find them. Seeing how a small-cap company has performed will influence your decision of adding them to your portfolio or not.
Finally, Know the Risks
Investing in any company comes with risks, but small-caps tend to contain the most risk. Their volatile price swings and limited financial resources deem them an unsafe investment. Because they are smaller, stock price tends to fluctuate about 5% or more in a single trading day. There is a chance that you can go through major losses because of the precarious nature of small-caps.
Knowing these risks will help you better understand what measures to put in place when investing in small-caps. For example, portfolio diversification is essential as it could help you with any losses you may come across when investing in a small-cap company. If you lose money from small-cap investing, returns from other investments could cover your losses and still make you some money.
Despite the risks, you can make great returns from small-cap companies. When you know what steps to take and how to properly consider all the factors, small-cap investing becomes less risky. If you are educated on what affects small-cap performance, then you are more likely to invest in a small-cap that performs well. It all comes down to considering market types, analyzing market trends, knowing about your small-cap company’s earnings, and being cognizant of the risks small-cap investing comes with. Of course, executing these steps when analyzing small-cap stocks is not a foolproof way to prevent any losses. Take your time to really research investment opportunities, and invest in one when you feel comfortable and confident.
This article does not necessarily reflect the opinions of the editors or management of EconoTimes