Small Caps Explained

There are many ways to categorize different types of stocks.  And there are a variety of ways to categorize levels of risk in the stock market.  One way to do both is by the market cap.  The market cap is the measure of the size of a corporation.  It is calculated by multiplying the share price by the number of outstanding shares issued by the company.  To give you a reference point, to refer to the size of Microsoft we would use their market cap of $220 billion to express that figure.

There are 3 major types of market cap sizes.  There is the small cap, mid cap, and large cap stock categories.  Small cap stocks are companies under $2 billion in market cap.  Mid cap is $2 – $10 billion and large caps are over $10 billion.

Small caps have several points of attraction for investors.  First of all, they are too small for large institutional investors to want to look at.  That means the big guns are minimized as your competitors and you have a better advantage in finding good deals among small companies.  Often it’s not worth it for them to bother with these sized companies.

Secondly, small cap stocks have the most room for growth.  That means you can find a lot of relatively cheap companies with the potential to become the next Google.  And that is the essence of small cap investing, you are looking for the next big thing.

This potential for high gains also brings with it an equal amount of risk and volatility.  Many small caps will succeed and go on to become mid and large cap stocks.  But many will fail.  The best investment advice that I can give you is to diversify.  In order to mitigate overall losses to your portfolio, you should invest in a variety of stocks to spread your risk.  If you invest in 5, and 4 fail but 1 goes on to become the next Microsoft, than you will make up for your losses in the other 4 stocks.

You can also invest in mutual funds that focus on small companies.  You can get small cap funds that are geared toward growth, value or a mix of the two.  You can also get it in the form of an ETF, or exchange traded fund if you would like. Companies like Vanguard and Fidelity can offer you some good options in this area if you would like to save yourself the work and hassle of doing your own stock picking.