What is a small cap stock? First of all, "cap" is short for capitalization. Capitalization means the market price of an entire company, calculated by multiplying the number of shares outstanding by the price per share. Some people define a small cap stock as one with a market cap of less than $1 billion. But I like to define them as ones with a market cap of under $500 million. Over time, small cap stocks perform better than large cap stocks. The record is clear about that. However, in reading the commentary offered by investment pundits and Wall Street analysts there seems to be a heavy dose of skepticism about whether small stocks are appropriate for a significant percentage of an individual investor's portfolio. One reason for this skepticism is risk. It is true that small cap stocks are much more volatile than their big cap brethren. So in that sense, there is more risk involved. But there is also an attitude among the investment elite that the individual investor is too unsophisticated to handle risk. Therefore, individuals must be protected from themselves by limiting their small cap investments to a small percentage of an overly diversified portfolio. The last thing that Wall Street types want to do is empower you to make your own decisions. After all, if you're calling your own shots you don't need to pay for their advice, do you? And since Wall Street doesn't cover small stocks, it's in their best interest to steer you away from small stock investing. But the truth of the matter is that it's the very reason that Wall Street doesn't want you to focus on small cap stocks that gives you an advantage. Analysts for big investment firms don't cover the little stocks. There are just too many of them and they are too small and illiquid for their big institutional clients to buy. And since many small stocks aren't adequately covered, they can be very inefficiently priced. That inefficiency offers a great opportunity to those who are willing to do the research to uncover hidden gems. Super-star investor, Warren Buffett, has written, "Observing that the market was frequently efficient, the theorists went on to conclude incorrectly that the market was always efficient. The difference between the propositions is night and day." Buffett is saying that smart investors can find opportunities in stocks that are priced below their value. However, if you think you're going to get an edge by investing in Wall Mart, Microsoft, General Electric, and the like, you're just kidding yourself. Those stocks have been analyzed to death by teams of Wall Street analysts. What is known about them is already priced into the stock. There is no way you're going to be able to uncover information that is not already widely known by everyone else. That's not true with small cap stocks. If you do your homework, you can find some really undervalued investment opportunities. You do have to manage your risk. But that's always the case in any investment you make. So don't let the financial media and Wall Street elites keep you from using the biggest advantage that you have over them -- the ability to find investment opportunities that they can't take advantage of. And you're going to be able to find those opportunities within the ranks of small cap stocks. |
