What are Small Cap Stocks?

These stocks are usually available at a low price, despite massive growth potential. They are also very volatile—extremely sensitive to market fluctuations. As a result, small cap investments offer superior returns in the long run and may not be profitable in the short term.

Key Takeaways

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Small Cap Stocks Explained

When a small cap company trades equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company’s balance sheet.read more, it is referred to as a small cap stock. Newly established businesses with massive growth potential are called small cap companies. The market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more of small cap companies ranges between $300 million and $2 billion.

The Russell 2000 is a small cap index that replicates the performance of two thousand small cap stocks in the US. It is known to exceed the performance of the S&P 500—five hundred large-cap public companies in the US.

Holding small cap equity in isolation is too risky. Therefore, investors diversify their portfolios by combining large-cap and mid-cap stocksMid-cap StocksMid-Cap stocks are the stocks of the companies having medium market capitalization. Their capital lies between that of large and small cap companies and valuation of the entire share holdings of these companies range between $2 billion to $8 billion.read more with small cap options to spread the uncertainty. In a favorable market, portfolio diversificationPortfolio DiversificationPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more improves the overall returns. Even then, small cap risks cannot be overlooked—many fail miserably and become bankrupt.

Features

The following characteristics distinguish these stocks from other investment instruments:

  • Low Price: Due to low market capitalization, the price of these stocks are usually low, and therefore affordable for small investors.High Risk: Small companies are very sensitive to market fluctuations.High Return: These investments have the potential to generate huge profits in favorable market conditions.Long-term Perspective: They offer positive returns in the long run. However, short-term holdings of small cap stocks may even result in losses—due to high market riskMarket RiskMarket risk is the risk that an investor faces due to the decrease in the market value of a financial product that affects the whole market and is not limited to a particular economic commodity. It is often called systematic risk.read more.Taxable Gains: The profit earned by selling these stocks comes under the investor’s taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.read more.Low Liquidity: They are not very liquid—they are not available at the favorable price for purchase—cannot be sold at the desired price.

Investing in Small Cap Stocks

The performance of US small cap stocks has surpassed the returns of US large-cap stocks. As a result, there is scope for massive gains in the long term. Moreover, these companies can grow fast because they are at a flourishing stage where they can innovate and take risks.

Small cap companies greatly impact a nation’s economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more—they increase job opportunities. However, due to low market capitalization, they are not given due consideration from business analysts—most valuations of small cap stocks are inaccurate.

Best Small Cap Stocks

Following is a list of the best small cap stocks to buy as of 2022:

  • Portillo’sPortillo’s Inc. (PTLO) Global Blood Therapeutics Inc. (GBT)Bright Health Inc. (BHG)Allogene Therapeutics Inc. (ALLO)BridgeBio Pharma Inc. (BBIO)Vnet Group Inc. (VNET)Vroom Inc. (VRM)BTRS Holdings Inc. (BTRS)Sangamo Therapeutics Inc. (SGMO)

The pandemic has paved the way for small cap companies to innovate and grow. Nasdaq recommends the following small caps for 2022:

  • Titan International, Inc. (TWI)One Stop Systems, Inc. (OSS)Beazer Homes USA, Inc. (BZH)Lazydays Holdings, Inc. (LAZY)

Small Cap Vs. Large Cap Stocks

This article has been a guide to what are small cap stocks & its definition. We list best high growth small caps stocks/indices & discuss how to find/buy/hold them. You may also read articles on corporate finance –

The following steps can help discover profitable small caps: 1. Sort small cap companies based on high potential. 2. Evaluate each company’s financial strength, sales, and revenue growth. 3. Figure out the correct valuation of its stock. 4. Carefully research the firm’s dividend policy, shareholder policy, and employee review.

In January 2022, small caps have dipped by almost 40%—compared to their 52-week high. The possible reasons for the downfall are high volatility and market correction. However, many market strategists are still positive that the stocks will bounce back.

Investors who have a considerable risk appetite and ambition to accrue huge long-term profits can invest in small cap companies.

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