Small cap stock investing is volatile. That is one of first things you should know and understand. So, why risk your money by investing in what is typically considered risky business? First and foremost – increased risk equals increased potential reward. However, there is another way to look at it. Investing in risk can actually decrease the total risk of your portfolio. Here is how it works. By diversifying your portfolio to include high volatility, moderate and minimum risk instruments the overall return tends to be greater thereby actually eliminating risk by increasing volatility. Small cap stock are defined as those companies with a market cap of less than $1 billion (calculate market cap by multiplying share price by number of outstanding shares). Size matters when it comes to small cap stock investing. Just ask yourself, what is easier to do – double your money from $1 to $2 or double $1 million to $2 million. It’s a no-brainer. The same applies to corporations. Growth becomes more difficult as the company grows beyond a certain point, but the rewards for finding the right company in the early growth stage can lead to the type of returns every investor dreams of. Use these quick tips when searching for small cap stocks:
- Understand the market. Yes – we are saying it again for a reason. The fundamentals never go out of style and there are few places this is more true than investing in small cap stocks.
- Don’t believe the better mouse-trap theory. You know the old adage “build a better mouse-trap and they will come.” The reality is closer to “imitation is the best form of flattery.” Before you bet the farm on the next new and improved technology, remember how much money is required to bring it to market.
- Stay involved with the company. Read and understand the company information itself. Who is at the helm? What is their prior experience? The best plans fall apart without proper guidance.
Small Cap Stock Selection Checklist
Not sure what to look for when purchasing small cap stock? Use this small cap stock selection checklist to make sure you cover the basics:
- Earnings. Look for a rise in current and annual earnings. Some investors will use a 25 percent increase in current earnings per share, but that is heavily contingent upon prevailing market conditions and the industry averages.
- Volume. Trading volume is critical especially when dealing with small cap stocks. Remember, to make a profit you need someone willing and able to buy what you are selling.
- Institutional sponsorship. Look for investment by mutual funds and other large institutional buyers.
- Growth. Read analyst reports for growth forecasts of 15 percent and up.
- Revenue. Look for revenue or sales growth of at least 15 percent change above year over year rate.