Investors who don’t recognize the big performance potential of small-cap stocks could be missing some compelling investment opportunities.
Market capitalization, a measure of a company’s size, is the total dollar value of all outstanding shares of stock. (It’s calculated by multiplying the number of shares by the current market price.) Stocks with a relatively small market capitalization are considered small capitalization (or small cap) stocks.
Although small-cap companies are diverse-there’s no clear definition of just what range of market capitalizations a stock has to fall into to be considered small cap they do share some characteristics. For example, their size can allow small-cap companies to react more quickly to changes in the economy than larger companies (which explains why small-cap stocks have traditionally performed well when the economy is emerging from a downturn).
This is why some investors turn to small cap stocks: They offer diversification potential. While diversification can’t guarantee a profit or ensure against a loss, it can help even out the ups and downs of a portfolio.
Of course, no stocks are without risks. Any stock represents ownership in its issuer, and stock prices can be hurt by poor management or shrinking product demand. However, this may be accentuated in smaller companies.
As a result, you may want to consider diversifying the small-cap component of your portfolio by investing in a variety of small-cap stocks. Purchasing shares of a mutual fund that invests specifically in small-cap stocks is one way to do this. Discuss your options with your advisor.