What Is the Definition of a Small Cap Stock?
Small cap stock can be a lucrative investment because it often has low trading prices (more than likely a small cap stock trades below $5) and it offers potential for rapid growth, especially if the company is in a hot sector or has an impressive new product. While the definition of small cap stock isn't limited to a particular sector or industry, it is generally defined as a company with a market value of $300 million to $2 billion. It is important to check with your broker as the market value used to define small cap can be different at various brokerage firms.
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Owning Small Cap Stock
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Investing in small cap stock can be rewarding for investors because it can mean finding the next big thing before the rest of the market. Most mutual funds have to own stocks trading above $5 or $10 a share and therefore are forced to ignore the small cap universe. Fortunately, regular investors aren't so restrained and owning a couple of small cap stocks can help balance a portfolio that has lots of big cap names in it.
Don't Get Confused
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While investors may think there aren't classes of stock below small caps, there are. Micro caps and nano caps are even tinier than their small cap peers and are often less liquid. In addition, stocks below the small cap are likely to be attached to companies with poor financial performance, weak businesses and are not subject to regular reporting requirements.
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Advantages of Investing in Small Cap Stock
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Smalls cap stock is easy to find, especially by the definition provided above, and by some estimates, it is the largest group of stocks on U.S. exchanges, accounting for nearly 1,900 of the listed stocks in the United States. Another advantage, and probably more important is the fact that small cap stock historically outperforms its larger peers.
Dangers of Small Caps
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The primary danger of investing in small cap stock is that the stock may have previously been a large cap stock that fell out favor with investors and was subsequently sold off. Stay from these names. Another factor to evaluate is the trading volume in small cap stock. Some small cap stock may be hard to sell if there isn't robust daily volume.
Conclusion
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The bottom line is that small cap stock can provide large returns, but investors should overload their portfolios with this particular asset.
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