Some of us prefer to take the path less travelled. That path often has unknown risks, but it also rewards you generously, because there are very few people reaping the benefits. Similarly in the stock market, we tend to like esoteric companies and companies that are micro-cap, the smaller end of the small-cap universe. Since very few people are interested in them, there are automatically lesser number of analysts covering them and fewer number of institutional shareholders. This often leads to really attractive, lucrative opportunities while walking down the off-beat track.
Pros and Cons of Small-cap Stocks
Small-cap stocks are not tracked by analysts, so their real value are often undiscovered for a long time. While on one hand that is a pretty risky area to venture, but the rewards are unlimited. Finding a hidden gem like a micro-cap or small –cap to become a mid-cap or a large-cap stock overtime can provide you superb returns. While small-cap stocks might prove to be beneficial and profitable, but it takes a lot of time to reach its true value. These stocks are meant for the long haul, and people who are looking for a quick buck will be disappointed by this.
However, small-cap stocks have low trade volumes which makes their buy/sell process time consuming. If you end up buying a wrong stock, it will be difficult to sell your way through. Most small-cap companies also have short track records which makes judging their performance extremely difficult.
How to Invest?
- If you’re walking down this path, consider trading in active stocks rather than passive ones. The reason for saying this is because an index invests in every single of its component stocks irrespective of their attractiveness. Noteworthy is the fact that some of the best stocks are never in the index, they get included only when there has been significant price gains.
- When it comes to small-caps, the issue of execution is extremely important. This is because small-caps have generally low levels of liquidity and wider bid/ask spreads. Investors tend to lose out on gains when they enter/exit.
- Your focus should be on reducing risk by looking for stocks with a safety net to fall back upon like a strong balance sheet, higher cash flow, etc.
- When you’re investing in small-caps, look for stocks that have a catalyst involved. That catalyst can be anything ranging from consolidation of an industry, upcoming resolution of a lawsuit, breakup potential, etc.
If you’re seeking gold, you have to realize that you will hardly find that lying about on the surface. You will have to dig, and dig deep to find the gold you seek. You have the ability and the opportunity to capture alpha in small-caps if you look hard enough and seek the less trodden path for your own glory.