Small-cap stocks belong to lesser-known companies and are therefore considered a risky bet. They are highly volatile with very few expectations from them. However, it is important to understand that every large-cap stock was once a small or mid-cap stock.
The secret to creating wealth with small-cap stocks is to discover superior small-cap stocks early and invest in them for a long period.
Here are some tips to evaluate small-cap stocks to unlock wealth-creation opportunities.
What is Small Cap Investing?
Small-cap investments focus on companies with small market capitalization. Due to their small size and lack of liquidity small-cap companies are often considered high-risk investments. However, they also offer greater potential for growth compared to large-cap companies.
Small-cap investing involves a lot of research to evaluate the financials of the company. When investing in small-cap companies, diversifying your investments is even more important. Instead of investing in an individual company, choose a portfolio of small-cap stocks to diversify your investments.
Risks of Small Cap Investing
- Higher Chance of Default: There is a higher chance of the companies defaulting on their loans or going bankrupt.
- Lower Liquidity: They have a lower trading volume which makes it difficult to buy and sell stocks.
- Greater Volatility: Small-cap stocks are subject to higher price movements which can lead to substantial losses for the investor.
Rewards of Small Cap Investing
- Higher Potential of Returns: Small-cap companies also tend to have the potential for higher returns early in the trajectory.
- Possible Diversification: Investing in small-cap stocks is also a way to diversify your portfolio.
Tips to Evaluate Small Cap Stocks
- Analyze the Financial Strength of the Company
Before investing in small-cap stocks, you should evaluate the financial strength of the company. The stock price is likely to grow if a company has a sound financial background. Analyzing financial strength includes evaluating cash flow, balance sheet, and liquidity ratios. A company with low debt and consistent cash flow has a higher growth potential.
- Check Sales and Profits Over a Long Period
Small-cap companies are dependent on their sales. So, before investing in a small company check its profits and sales over a period of 5 years. If the sales and profits are growing, it is an indication that the company has future potential and can provide good returns in the long run.
- Do a Background Check of Promoters and Management
Before investing in a small-cap company, you must do a thorough evaluation of the company’s management and promoters. Quality of management is extremely crucial for a small-cap company. Even a minor management error can have a major impact on the price. That’s the reason small-cap stocks are highly volatile in nature with major price fluctuations.
Conclusion:
Small-cap investments carry higher risk but with proper research and following a long-term strategy you can also unlock wealth creation opportunities. It is important to evaluate the risks as well as the rewards of small stock investing to make informed decisions.
