Stock Market Cap Analysis, Part III - Small Cap Stocks

We can analyze stocks by organizing them by their market capitalization. Market cap is computed by multiplying the share price by the number of shares outstanding. For example, if a stock was trading at $75 per share, and it had 1 million shares outstanding, its market capitalization would be $75 million.

In this article, we will examine small cap stocks. These are companies with market caps between $300 million and $1 billion.

Here are some of the features of small caps:

1. High growth rates - Small cap companies are usually in growth mode. Either they are selling a new product or service, or else they are well-established in a certain region and are looking to expand. This means that the stock price may appreciate a lot in the near future, as earnings and sales increase.

2. Less well-known and analyzed - Small caps are usually not extensively followed and analyzed by Wall Street.

3. More risky - Small cap stocks are riskier than medium and large cap stocks because they may not have the stable cash flow, deep management talent, clout, and lines of credit to weather strategic mistakes and/or down markets. Since the stocks aren't heavily followed and analyzed by Wall Street firms, investors may not learn about bad news before the share price fully reflects the information.

4. Less insulated from stock market trends - Not only do small companies themselves lack the resources to resist bear markets, but investor behavior itself exaggerates the effects of market conditions. Investors are quick to jump out of small caps when the market turns down, and they are quick to jump aboard during bull market runs.

Remember that your portfolio should not consist solely of small cap stocks. For diversification, your portfolio should contain stocks that have been selected from among all the market cap categories.

Success in stock trading depends on both stock selection and having a system for knowing when to buy and sell.