Things to Look For When Investing in Small Cap Stocks

Looking at the numbers, it is clear that small-cap stocks are performing considerably better than large-cap stocks. If you are looking for information on whether small-cap stocks are a good investment, you are golden. Over the past 20 years, the average annual return for the S&P 600 small-cap stocks is 10.5%. This is higher than the S&P 500, which is at 7.9% within the same time duration. What may keep you from benefiting from these stocks is not finding the right ones and not knowing how to invest for higher profit margins correctly. Investing in small-cap stocks does not have to be complicated.

Here are a few things to look for to ensure that you are doing it correctly.

Paradigm shifts that are opening up new opportunities

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You need to always be on the look put for paradigm shifts that open up unique opportunities for stand-alone companies to come up with new solutions to the problem. You can then look for an equal benefactor to that pioneering company and invest in them too. Most of these companies will remain unnoticed until they are well into the transition into industries. It means that you need to really take your time with the research to ensure that you get everything right.

Only invest when the market opportunity is quantifiable and huge

This is also known as the law of large numbers. You should only invest in small companies if they serve large markets. This is mainly because companies can realize tremendous growth even when the market share is small. The size of the company determines the potential gains and helps you reduce your risk profile. The companies that take advantage of the potential market will grow, and so will your profit. Capturing even a fraction of a growing market could lead to enormous gains for an investor.

Invest before large institutions notice the companies

This is a strategy similar to that of robbing the train before it gets to the station. This move will help you reduce your risks, and your investment profits will increase before most of the bigger investors step into the scene. These larger investors may include pensions, mutual funds, and hedge funds. Always look for companies with less than 50% institutional ownership. If the institutions come into play, the value of the stock will increase.

Check for growth and value

Growth-oriented, take-over-the-world ideas are great. However, as an investor, you also need to check the valuation. Only buy if the valuation, compared to peers, is reasonable. A great investment would be a company with excellent sales growth, and it is undervalued when looking at market potential against total market capitalization. You may also need to check the balance sheet. Invest only in companies that have minimal debt.

Conclusion

The main aim of any investment is to reduce the amount of loss you encounter. If you do not encounter losses, you will be able to rest easy every night. Experts also advise that you should only invest small amounts of cash into several companies to prevent catastrophic losses.

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