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If you are new to investing then there’s a lot of jargon to get your head around. One of the terms you may have heard is ‘small cap stocks’. But what are they, and how do they differ from other kinds of stocks?
The ‘cap’ part of small cap stocks means market capitalisation. A company’s market capitalisation is calculated by multiplying the company’s share price by the total number of outstanding shares. For example, if a company has 5 million shares outstanding and the price of the stock is £20, then the company has a market cap of £100 million.
Small cap stocks means companies with a relatively small market capitalisation – generally between £50m and £230 million. This is very different from the US, where stocks in this category have much larger market caps, ranging between $300m and $2bn.
Other types of stocks are mid cap stocks (£1b to £5b), which offer a middle ground, and large cap stocks (more than £10b).
| Stock size | Market capitalisation |
| Small cap | £50m to £230m |
| Mid cap | £1bn to £5bn |
| Large cap | More than £10bn |
Start by identifying your investment objectives – it could be long-term growth, income or a combination of the two.
Research the companies you are interested in before picking which stocks to buy.
You buy small cap stocks through a broker, just like any other stocks.
You could also invest in a small cap fund which covers many different companies.
Small cap stocks have the potential for strong earnings growth. They are often new or early-stage companies that have scope to increase their annual profits much faster than companies that have been longer established. This offers investors an opportunity for higher returns. Since the companies can grow quickly, returns can come faster than larger, more established companies.
Smaller companies can also be the target for mergers and acquisitions.
In addition, small cap companies can be overlooked by analysts, which means they are undervalued. This increases the potential for growth.
Small cap companies are typically less established and have less financial stability. The share price can be more prone to market volatility, because their small size makes them more sensitive to changes in market conditions.
The companies’ financial resources may not be strong enough to protect them through economic downturns, making them more of a risk than larger companies.
Small cap stocks may have lower trading volumes than larger companies. This lower liquidity can make it more difficult to buy or sell the stocks at your desired price.
Make sure your portfolio is diversified – do not put all your eggs in one basket! Consider spreading your investment across companies from different sectors, and of different sizes. This helps mitigate the risks that come from individual companies or industries.
It is important to do your research and understand the risks involved in investing in small cap companies. Consider the company’s financial health, management team, growth potential, and competitive position in the market. You should also look at industry trends for the sector in which the company operates.
| Stock size | Advantages | Disadvantages |
| Large cap | ✔ Companies are established and have a long history of stable earnings. | ✖ Potential for high returns is lower. |
| ✔ Companies’ market share in their industry is large. | ||
| ✔ Companies are considered more stable and predictable. | ||
| Mid cap | ✔ Companies have significant growth potential. | ✖ Companies are less established than large cap companies. |
| ✔ Companies grow rapidly. | ✖ Can be subject to more volatility than large cap stocks. | |
| Small cap | ✔ Long term potential for high returns. | ✖ Companies are less established and have less financial stability. |
| ✔ Companies can offer greater opportunities for growth. | ✖ Stock prices are more prone to market volatility. | |
| ✔ Companies are often overlooked by analysts, providing opportunity for undervalued stocks. | ✖ Companies may not have the same level of financial resources to cope with economic downturns. |
Here are some of the frequently asked questions about small cap stocks:
1. Will small cap stocks be a good investment for me?
Small cap stocks can be a good investment because they offer potential for great returns, but it is important that you understand the risks involved.
2. What are the risks involved with small cap stocks?
Small cap companies can have less financial stability, less, liquidity, and the share price can be volatile. They may also be more susceptible to economic downturns, and they have a greater chance of failing.
3. How do I invest in small cap stocks?
You can buy small cap stocks through your broker, you can invest in a fund that bundles small cap stocks together into one investment, or you can trade the stocks through a CFD which means you don’t actually own them.
4. What factors should I consider when selecting small cap stocks to invest in?
You need to research the companies before investing. Look at the company’s financial health, its management team, its competitive position in the market, its potential for growth, and trends in the industry.
5. What are some strategies for investing in small cap stocks?
Some strategies you should consider when investing in small cap stocks are to diversify your portfolio so you do not rely just on small cap stocks, to research individual companies thoroughly before plunging in, and to consider buying small cap funds instead of individual stocks.
Remember, it’s important to do your research and seek the advice of a financial professional before making any investment decisions.
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