Definition
Small cap stocks refer to shares from relatively smaller publicly traded companies with a market capitalization ranging between $300 million to $2 billion. Market capitalization is calculated by multiplying the company’s stock price by its number of shares outstanding. These types of stocks are often considered more volatile and risky compared to large cap stocks, but they have significant growth potential.
Key Takeaways
- Small Cap Stocks refer to the shares in relatively smaller companies. These companies are usually those with market capitalizations of between $300 million and $2 billion.
- Investments in Small Cap Stocks carry a higher risk due to their potential instability but at the same time they offer higher growth potential. This is mainly due to their smaller size, which allows them to readjust and innovate faster than larger companies.
- They tend to be under-followed by analysts, which means that diligent investors can often find undervalued stocks due to the lack of market attention.
Importance
Small Cap Stocks, which represent companies with a relatively small market capitalization (typically between $300 million to $2 billion), are an important aspect of finance due to their significant growth potential.
Unlike large or well-established corporations, these enterprises may still be in their developmental stage but have a unique potential to expand, enhance their operations, and increase their profitability.
Furthermore, they are often less followed in the market, resulting in greater chances for mispricing and lucrative investment opportunities for astute investors.
However, investing in small cap stocks also entails higher risk due to their susceptibility to market volatility and other business-related risks.
Ensuring a diverse portfolio with a well-balanced mix of small cap stocks can help investors manage these risks while benefiting from potential high growth.
Explanation
Small Cap Stocks represent small-cap companies with a relatively smaller market capitalization, generally ranging between $300 million and $2 billion. Their purpose in the financial landscape is multifaceted, as they present unique avenues for potential growth and diversification in an investor’s portfolio.
Likely to be young companies at potentially early stages of their business cycle, they may offer robust growth potential. Their comparatively smaller size creates opportunities for significant revenue and profit elevation, especially when these firms are on the brink of breaking into larger markets or developing industry-disruptive products/services.
Small Cap Stocks are commonly used for speculative investments due to their size and their stage in the business cycle. They are most beneficial to investors who are risk-tolerant and looking for aggressive growth opportunities.
Moreover, Small Cap Stocks are also utilised to diversify a portfolio; their performance isn’t generally synchronized with large-cap stocks, which creates a cushion against market volatility. However, it’s crucial to incorporate them through a measured approach due to inherent risks, such as higher volatility, lower liquidity, and less transparency.
Examples of Small Cap Stocks
Etsy Inc. (ETSY): Etsy is an American e-commerce website focused on handmade or vintage items and craft supplies. For quite some time, Etsy was considered a small-cap stock because the total value of all its shares of stock on the market — its market capitalization — was under $2 billion. Etsy has grown considerably in recent years, but it’s an example of a successful small-cap stock.
Cheesecake Factory Inc. (CAKE): The Cheesecake Factory is an American restaurant company and distributor of cheesecakes based in the United States. The company operates 220 full-service restaurants. It is also considered a small-cap stock due to its market capitalization, just over $1 billion.
GoPro Inc. (GPRO): GoPro, the manufacturer of action cameras, is another example. Following a high-profile initial public offering (IPO), GoPro’s market capitalization has consistently stayed below the $2 billion mark, placing it in the small-cap category. The small-cap category generally includes companies with market caps between $300 million and $2 billion.
Frequently Asked Questions about Small Cap Stocks
What are Small Cap Stocks?
Small Cap Stocks refer to the stocks of companies with a smaller market capitalization, usually between $300 million and $2 billion. These stocks are generally considered riskier than mid-cap or large-cap stocks, but they often have significant growth potential.
How are Small Cap Stocks different from Large Cap Stocks?
Small cap stocks are shares from smaller companies, while large cap stocks are shares from bigger, more established companies. The “cap” in both of these terms stands for capitalization, which is calculated by multiplying the current share price by the number of outstanding shares.
What are the risks and rewards related to Small Cap Stocks?
Investing in small cap stocks can be riskier due to the relative instability of smaller companies. However, the potential for growth and high returns is significantly greater compared to stable, slow-growing large cap stocks. It’s important to note that this comes with a higher level of volatility and potential for losses.
Where can I buy Small Cap Stocks?
You can purchase small cap stocks through brokerage accounts or directly from the stock exchange. Some discount brokers specifically focus on small cap stocks due to their high growth potential.
Should I consider adding Small Cap Stocks to my portfolio?
Adding small cap stocks to your portfolio can diversify your investments and potentially increase your returns. However, this should be based on your risk tolerance, investment goals, and understanding of these types of investments.
Related Entrepreneurship Terms
- Market Capitalization: The total market value of a company’s outstanding shares of stock. In small cap stocks, this is usually under $2 billion.
- Volatility: Small cap stocks often experience higher volatility than large-cap stocks, meaning their prices can change rapidly in a very short time.
- High Growth Potential: Small cap stocks, though risky, often have greater growth potential compared to large cap stocks.
- Risk/Reward Ratio: The balance of the potential risk faced when investing in small-cap stocks against the potential reward. The higher the potential returns, the higher the risk.
- Liquidity: Small cap stocks may be less liquid than larger cap stocks, meaning they could be harder to buy or sell without affecting the market price.
Sources for More Information
- Investopedia: This website provides a rich knowledge of investment and finance terms, including small-cap stocks.
- Morningstar: A reliable source of financial information, Morningstar provides data and insights on a vast number of small-cap stocks.
- MarketWatch: A financial information website that provides business news, analysis, and stock market data, including information about small-cap stocks.
- Bloomberg: Known for its coverage of financial news and markets globally, Bloomberg offers valuable insight into small-cap stock markets.
