Why Invest in Small-Cap US Stocks?
The equity or stock markets are compartmentalized into categories based on size, including large-cap, mid-cap and small-cap groupings. Small cap is composed of some of the smallest equity investments available based on market capitalization (market cap), the combined value of outstanding stock and debt. These companies tend to be "pure play" investments in that they are focused on one primary business that drives in revenues. Also, these investments are often cheaper to invest in versus some larger-cap names.
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Identification
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According to financial services firm Axa Equitable, small-cap stocks are companies with market caps under $1 billion. Typically, these companies are focused on one line of business in comparison with a conglomerate, which has several revenue streams. This focus on a particular product or service often helps the company to generate generous profits under good economic conditions, but because of their size, small-cap stocks become especially susceptible to a slowdown during weaker economic times.
Types
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The small-cap category has more than one attractive option for investors. A small-cap mutual fund is a basket of small-cap stocks run by a mutual fund manager who invests on behalf of many different investors. The manager can buy and sell stocks as opportunities arise. A small-cap ETF is an index fund also made up of many small-cap stocks, but it tracks performance of an underlying index in the stock market.
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Considerations
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Small-cap stocks do not have heavy volume, meaning that there is less trading activity here than with larger names. These companies exhibit more volatility than industry leaders. Since there are fewer buyers and sellers, large transactions are noticed in the price of the stock more easily in both directions. An advantage to investing in stocks is that some pay dividends or cash distributions based on profitability to investors. Small-cap stocks usually do not but instead use profits to grow the company.
Profits
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Although small-cap stocks do not have the same financial muscle as their mid-cap and large-cap counterparts, they can still pay generous rewards to investors. One small-cap index, the Russell 2000, which comprises 2,000 small-cap stocks, soared over 20 percent for the one-year period ending in March 2011, according to CNNMoney. That was compared with a 13 percent gain for the S&P 500, a broad measure of stock activity in the U.S., during that period.
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References
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