Small Cap- Make your investments right !!

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Small cap stocks as the name refers are shares of small companies. Though what determines whether a company is “small”? The deciding factor is the market capitalization of the company, i.e. the value of the company measured by the price of one share multiplied by total number of outstanding shares. Any company valued up to 2000 cr. is a small cap company and its share is a small cap stock.

 


A small cap stock is many times a part of your portfolio. Mutual fund companies often include these in their portfolios as they provide an opportunity for diversification. They also have niche schemes such as large cap, mid cap and small cap. In this case, the investor would solely be investing in small cap companies. However, being small companies do these provide for a good investment opportunity or are these very risky stocks which should be strayed far from?  We at Fpguru.com would like to throw some light upon the positives and negatives of investing into small cap stocks and who exactly should be doing so.

 

Pros:


Huge growth potential: The first and the most important advantage that a small cap stock gives you is their high growth potential. Since these are small companies they have great scope to rise as opposed to already large companies. All large cap stocks were after all small cap stocks of the past. Small companies are on their growth stage and hence more keen on their business plans and future developments. They have less wastage and make more efficient use of resources. This also gives them an opportunity to rise and give their investors a hearty profit.


Low prices: Small cap stocks are priced lower than mid cap or large cap stocks. Hence it is useful for a trader who can trade in more number of stocks as compared to the others.


Under–recognized: Small cap stocks are often given the least attention by the analysts who are more interested in the large companies. Hence, they are often under - recognized and could be under-priced thus giving the investor the opportunity to benefit from these low prices.


Cons:


Risk: The first and the most important disadvantage a small cap stock is the high level of risk it exposes an investor to. If a small cap company has the potential to rise quickly, it even has the potential to fall. Owing to its small size, it may not be able to sustain itself thereby leading the investor into great loses. After all, the bigger the company, the harder it is for it to fall.


Volatility: Small cap stocks are also more volatile as compared to large cap stocks. This is mainly because they have limited reserves against hard times. Also, it in the event of an economic crisis or any change in the company administration could lead to investors disinvesting thereby leading to a fall in prices.


Liquidity: Since investing in small cap stocks is mainly a decision depending upon one’s ability to undertake risk, a small cap stock can often become illiquid. Hence, one shouldn’t depend upon them for an important life goal.


Lack of information: As opposed to a large cap company, the analysts do not spend enough time studying the small cap companies. Hence, there isn’t enough information available to the investor so that he can study the company and decide about it future prospects. Financial ratios and growth rates for large companies are printed for public viewing, but in case of small cap companies the investor has to begin from scratch. This also leads to huge time consumption for those who are interested in investing in them.


Dividend: Small cap stocks generally give fewer dividends to the investors. This is mainly because most of their earnings are invested into growing their company. Hence, this makes a very unsuitable investment option for those looking for income by way of dividends.


So, is it a viable option for investment? Small cap stocks definitely have the potential to provide you with very high returns but they are accompanied by high levels of risk. If you have the ability to undertake high levels of risk, small cap stocks are an arena for you to explore. However, if you fall in the conservative category of investors, it is most likely that you would not be able to handle the up’s and down’s that come along with a small cap stock.

 

 

By Shalmali Kulkarni.

The writer is working as a para-planner with Fpguru.com

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