To trade profitably in the stock market, you must familiarise yourself with the concept of market capitalization. Market capitalization is the determinant of a company’s value and decides if the company is a large-cap, mid-cap, or small-cap enterprise. With the correct knowledge of market capitalization, also known as market cap, you can plan your investment portfolio effectively. Here, the focus will be on small-cap stocks.
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What are Small-Cap Stocks
Companies with a market capitalization of below Rs. 500 Crore fall under the small-cap companies category. More than 95% of Indian companies come in this category. Small-cap stocks are shares of small-cap businesses that are listed on the stock exchange. Investors seeking a high return on investment often choose to invest in these. Additionally, investors willing to take higher market risks can also consider small-cap stocks for investment.
A share market app is a simplified, secure, and convenient platform to start investing in small-cap stocks. A share trading app offers a market analysis of small-cap companies that helps an investor add the right stocks to his investment portfolio.
Features of Small-Cap Stocks an Investor Should Know
The features of small-cap stocks that you should know are:
- Stock market fluctuations significantly affect the Net Asset Value of small-cap stocks. Small-Cap stocks are highly volatile and tend to perform well when the market is bullish but struggle when the market underperforms.
- Small-Cap stocks are a risky investment avenue as they heavily rely on market fluctuations. Stock market recession affects small-cap stocks, and they take time to recover from it.
- In proportion to the risk they pose, small-cap stocks are one of the top-yielding investment options. They may prove to be multi-baggers and provide more than 100% returns.
- Along with the initial cost of buying small-cap stocks, investors have to pay an annual fee, known as the Expense Ratio. The maximum limit of the Expense Ratio is 2.5% of the average Asset Under Management (AUM).
- You can invest in a small-cap stock for a short term or a long term. However, long-term investments in small-cap stocks offer better returns for a lower risk.
- The returns you get on a small-cap stock investment come under the income category and are subject to a capital gain tax.
Things to Check Before Investing in Small-Cap Stocks
Retail investors looking to invest in small-cap stocks are advised to consider the following points before investing:
- An investor should check a small-cap company’s past performance for at least the last five years before investing in its stocks.
- Investors can identify the next multi-bagger small-cap stock by studying the small-cap company’s working capital, stability, and quality of management.
- You must also look at the risk of a small-cap company’s business model before investing in its stocks. Some businesses tend to take an undue risk and may not be a good investment choice.
- Investors should also study the company’s stability when the market conditions are unfavorable. It will show the soundness of a company during turbulent times.
- You can study the future trajectory of a small-cap company by looking at its growth margin and profit margin.
- Lastly, consider the stock’s liquidity before investing in it. It is advisable to prefer small-cap stocks with higher liquidity.
Benefits of Investing in Small-Cap Stocks
Here are the benefits of investing in a small-cap stock:
- The organic growth rate of small-cap companies is higher than large-cap or mid-cap companies. They hold the potential to grow and acquire significant capital in the future.
- Retail investors get the benefit of fair pricing on small-cap stocks because institutional investors can make only limited investments in small-cap stocks.
- Small-cap stocks are usually low-priced because of market inefficiencies. Investors can research small-cap stocks on advanced stock market apps and acquire these growth-oriented stocks for a low investment.
Risks of Investing in Small-Cap Stocks
One should have an understanding of the risks associated with small-cap investments:
- Small-cap stocks have a higher exposure to market risks which can be mitigated only in the long term through planned asset allocation and a balanced portfolio.
- They offer relatively less liquidity to investors and make the process of sale complicated and time-consuming.
- Investors need to spend a significant amount of time and effort in researching small-cap companies to identify profitable small-cap stock options.
Small-cap stocks have a high growth potential, and if held for the right investment period, they can bring exponential returns. Investors are advised to consider their investment horizon and risk appetite before investing in small-cap stocks.