- Small cap means companies with small capitalization relative to other companies.
- The 251st company and below on an exchange, by way of market capitalisation, have been termed as small cap companies by Sebi.
- Even though small cap investments carry risk, but they may also have huge growth potential.
What is a Small Cap?
Small cap means companies with small capitalisation, relative to other companies. The 251st company and below on an exchange, by way of market capitalisation, have been termed as small cap companies by Sebi.
Small caps make for the riskiest of stocks as they generally have small revenues, small teams, and small customer bases. Information about them is hard to come by. Investors usually go by future prospects, goodwill, and likely profitability of such companies before buying their stocks.
The incremental growth percentage is highest for small caps because of growth potential being far from fully realised.
Benefits of Small Cap Investing
Investing in a small cap business is often risky, but there are some significant advantages as well that investors usually do not realize. Some of them are:
Present day large cap companies were also small cap when they first entered market. Younger firms today, coming up with new ideas and technology with lesser capital can prove to be very successful in future. Investing in a promising small cap, with huge potential, today can lead to greater returns in future. Small cap businesses have potential to grow in ways that are not feasible for large and mature businesses. At some point, mature businesses start facing trouble in growing at the same pace as they used to because of the lack of growth potential available to them.
Large mutual funds often avoid investing in them:
It often happens that large mutual funds invest huge amounts of money in a single company. Such investments are not possible for a small cap business to support. It gives opportunity to individual investors to spot promising small cap businesses and invest in them before the larger institutional investors start investing in it leading to increase in its price.
Disadvantages of investing in a Small Cap
The drawbacks associated with investing in small cap businesses are:
It cannot be denied that making an investment in small businesses has more risk than doing so in well-established larger businesses. The valuation of a small cap is often done based on its growth potential. For an investment to yield desirable returns, it is important for a small cap to grow as per its valuation and that is the main source of risk. Not many businesses can successfully grow like Amazon, Netflix, etc.
Finding a small cap with truly promising growth potential itself requires considerable time for proper research. Various financial ratios are easily available for large businesses but the same is not true for small caps. You may be needed to do most of the number-crunching by yourself.