by Kevin Thalersmith

Created on: April 03, 2010   Last Updated: April 04, 2010

The main goal of most investors is to grow their portfolio much larger than it was when they started investing.  Over the years many different investment strategies have evolved to allow investors to achieve this goal in an appropriate amount of time.  In general, the background behind each strategy is the more risk taken, the higher the profit. 

An investor who buys only large-cap blue chip stocks will probably not lose money, but will only gain from the stock’s dividend and a small amount of growth in the stock’s price. That’s why small-cap stocks are the better choice for investors wanting more growth in their portfolio.

What are Small-Cap Stocks?

The term “small-cap” refers to the market capitalization of a stock.  This is equal to the total equity value of a company and is found my multiplying the total number of outstanding shares in a company by the price of one share. 

Companies whose market capitalization is between 300 million and 2 billion are considered to be small-cap.  Companies who have bigger market caps are called either mid-cap or large-cap and most companies smaller are considered micro-caps.

The Benefits of Small-Caps

Most small-cap companies’ stocks are considered growth stocks.  Their value to investors comes from the company’s ability to grow itself by large amounts each year.  This growth is then reflected in a stock’s earnings, which is what controls a large portion of a stock’s price. 

Increased earnings mean increased stock prices.  There is also a saying that there is no such thing as a 500 million dollar company.  The market cap either goes to 0 or over 1 billion dollars.  It is a stock’s ability to double in price that attracts investors to growth stocks. 

If the company will succeed, it will either grow by multiples or be bought by a large-cap company.  Either way, investors stand to profit.  It’s this opportunity to grow so much that makes small-caps appeal to investors who need to grow their portfolio.  In a relatively short amount of time, a small portfolio can easily become a medium, or even big, sized one.

The Risks of Small-Caps

Whether discussing any sort of investment, it’s important to understand the potential risks of the investment.  The chance of a large-cap stock like Exxon Mobil or Wal-Mart going bankrupt is very small.  Please note this doesn’t include issues like fraud, but it’s almost impossible to predict those types of events. 

On the other hand, many small-cap stocks are relatively unknown companies who could as easily fade out of existence as become a mid-cap.  But it’s this risk that provides investors with the chance to profit from small-caps.      

Small-caps are a great investment choice for the investor who wants to quickly grow his or her portfolio.  They’re perfect for young investors who don’t have much money to invest, yet have plenty of time to make up any money lost on small-cap stocks.  But whether you’re young or old, rich or poor, every portfolio should have some exposure to small-cap stocks.  They’re an essential part to any diversified portfolio.

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