Introduction
Small-cap stocks are shares that represent ownership in small companies. Their market value ranges from $300 million to $2 billion. Market value is measured by the number of shares outstanding multiplied by the price per share.
Advantages and Disadvantages
Small-cap companies have greater growth potential. It is easier for them to grow because they have a smaller operational and financial base. Their smaller size also makes investments riskier. They do not have the financial cushion to withstand crises or mismanagement.
Small-cap companies tend to perform particularly well at the beginning of an economic recovery. This is due to lower interest rates, which provide them with easy access to funds for investing in their growth.
On the other hand, they are also the riskiest stocks during an economic downturn. Small companies are more likely to fail during a recession. Therefore, you should reduce your allocation to small-cap stocks when the business cycle enters a contraction phase.
Small-Cap Stocks vs. Micro-Cap Stocks
Small-cap stocks are considered part of micro-cap stocks, which have share prices of $5 or less, making them cheap to buy. They are often difficult to sell, according to the Securities and Exchange Commission (SEC).
The SEC warns that you could lose your entire investment in micro-cap stocks.
Micro-cap stocks are often from unknown companies, and there is not much information available about them. This makes it difficult to determine their true value. Most buyers are not willing to take that risk.
Small-Cap Stocks vs. Large-Cap and Mid-Cap Stocks
Large-cap stocks have a market value of over $10 billion. They are the least risky because their assets will help them weather any market downturns.
Mid-cap companies have a market value ranging from $2 billion to $10 billion. Mid-cap companies have outperformed both small-cap and large-cap stocks over the past decade. This is because they are small enough to grow faster than large-cap stocks during expansion phases. Their size means they are not as prone to bankruptcy as small-cap stocks during contraction phases.
Small-cap companies have an advantage over large-cap and mid-cap stocks during expansion phases. Their stock prices will rise as the company grows. Large-cap stocks lose popularity during expansion phases as they are seen by investors seeking financial returns as boring and unexciting.
Examples
You may not have heard of most small-cap companies. Most are related to small finance, credit, or mortgage companies. You can see how risky it would have been to own them during the 2008 crisis or the 2020 recession.
Please note that this is not a recommendation in any way to buy stocks. One should rely on the wisdom of a financial advisor before purchasing any stock. Whether small-cap stocks fit your investment goals is always a personal decision.
There are some known small-cap companies. Here is a list of some companies you may have heard of to give you an idea of a small-cap company.
Bed Bath & Beyond BBBY Market Value: $1.1 billion Retail Industry
Office Depot ODP Market Value: $1.4 billion Retail Industry
Tuesday Morning TUES Market Value: $12.6 million Retail Industry
Groupon
GRPN market value: $741 million Coupon industry
A financial advisor will also tell you whether you prefer to invest in individual small-cap stocks or a small-cap equity investment fund.
Impact of Small-Cap Companies on the Economy
Small-cap companies are a significant driver of job creation. Small businesses contribute to 65% of all new job opportunities. That’s why the federal government focuses on helping small businesses through loans and grants.
A small-cap company is typically well along the way. It must be performing well enough to qualify for an initial public offering (IPO). Before a small company can issue an IPO, it must satisfy an investment bank that it is a well-run company. Although small-cap companies are riskier than mid-cap or large-cap companies, they are less risky than investing in a venture before it goes public.
An IPO takes a small company from the private funding stage to becoming a publicly-owned company. At that time, its shares trade on the New York Stock Exchange or NASDAQ.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Corporate Finance Institute. “Small-Cap Stocks.”
U.S. Securities and Exchange Commission. “Important Information About Small-Cap Stocks.”
Fidelity. “Understanding Market Capitalization.”
Yahoo! Finance. “Aggressive Small-Cap Stocks.”
Library of Congress Research. “Small Business Management and Job Creation,” page 5, table 3. Net Employment Change from Small Establishments, 2010-2018.
Source: https://www.thebalancemoney.com/what-are-small-cap-stocks-examples-and-effect-on-economy-3305889
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