How To Invest In Small Cap Stocks

A company’s market capitalization is defined by the market value of its outstanding shares in the stock market. It is calculated by multiplying the current share price by the number of its outstanding shares.

Small-cap stocks are stocks with a comparatively lower market capitalization. In India, small-cap companies are those that have a market capitalization of less than Rs. 5,000 crores.

Let’s say a company holds a total of 3 crore shares outstanding on the stock market today. The share price is Rs. 40 per share. Given the formula, the company’s market capitalization stands at Rs. 120 crore. Several brokerages may classify this company to be a small-cap company.

Features of small-cap stocks

  • Due to their market dependency, small-cap stocks are susceptible to market volatility. The fact that small-cap stocks are more likely to be affected by market recessions and take longer to recover from the same could make them a risky investment avenue for certain investors
  • They are different from penny stocks, which trade at a lower share price in the market. Although they fall under the small-cap category, small-cap stocks would trade at a higher price
  • Small-cap shares tend to be among the highest-yielding investment options
  • Small-cap stocks in India could be suitable for both long- and short-term investors. Investors should select small-cap shares with a long investment horizon to spread the risks associated with small-cap shares as well as generate substantial returns
  • Small-cap stocks tend to be heavily impacted by market fluctuations, which makes their net asset value volatile

Advantages of investing in small-cap stocks

  • Investing in stocks market could provide an advantage over institutional investors as they are bound by certain restrictions that limit their ability to push the stock price upwards
  • These allow individual investor to benefit from the market inefficiencies that underprice the small-cap stocks
  • When compared to large-cap companies, small-cap companies tend to have a better organic growth rate, thus giving them a better capital appreciation potential

Disadvantages of investing in small-cap stocks

  • Although the value of a small-stock company is based on its potential to grow, the risk of investing in small stocks tends to be higher than investing in any large- or mid-cap stock
  • Price fluctuations are extremely difficult to digest for many investors. It is due to the volatility that it tends to take a lesser volume of stocks to create a price difference
  • Small-cap stocks are less liquid; hence, it is difficult to exit at a certain position of the market price
  • It requires a dedicated investment of time to research to find small-cap stocks that have potential

Based on the above, a thorough analysis must be done before considering investing in small-cap stocks, as investors tend to focus on the negative aspects more. Do your due research before determining the quality of the stock and return on investment. You also need to consider your risk appetite, investment goals and horizon before deciding to invest in small-cap stocks.