How to Pick Small Cap Stocks
"Small cap" refers to companies with a market capitalization of between $300 million and $2 billion (market capitalization is calculated as the current stock price multiplied by the number of outstanding shares). Investors use market capitalization as a quick way to determine the size of a company. Historically some small-cap stocks have paid off very well--Microsoft and Apple had to start somewhere--and as a market have performed better than medium- and large-cap stocks. The challenge is trying to pick the right ones.
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Instructions
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Compare the stock's current price with its 52-week high/low trading range. You can find this information on your favorite investment research site. It's also usually posted on the company's website under Investor Relations.
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Compare P/E (price to earnings) ratios within the same industry. This is determined by dividing the current stock price by earnings per share. A higher/lower P/E ratio identifies an overvalued or undervalued stock. Small caps are traditionally undervalued in the market, but this will help to confirm and narrow your search field.
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Review the company's annual report, financial statements, and notes to the financial statements. Look at the income statement to compare revenue and net income. Look at the balance sheet for information on how much debt (liabilities) the company is carrying compared with assets. Look at the cash flow statement to see if cash flow is coming from operations or investing and financing.
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Look for signs of fast-paced growth. Negative earnings may be a sign that money is being invested for future growth. Look at the cash flow statement under Capex (capital expenditures) to see how much the company is investing in assets. A deficit in stockholder's equity (balance sheet) can be another sign of growth in the future.
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Understand the company's growth strategy and plans for the future. Research the management team to see if it has a previous track record for success. Research how much competition the company has by studying the industry--ideally, you want a company with a unique selling proposition.
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