Investments in Small Cap Stocks
Investments in small cap stocks could be compared to penny stock investments but the term ‘penny stocks’ is not specific enough. The thing is that the determination of penny stocks is based on stock price when the stock price means really nothing or mostly depends on outstanding share number. Because of that reason I will use as a criterion market capitalization which is more accurate.
Investments in small cap stocks are different from investments in blue chip stocks. The main difference is that blue chip stocks (or large cap stocks) are known by everyone and this makes the price of such stocks to be more efficient and more coherent to the fair market value. While small cap stocks (it includes microcap and similar terms) tell different story. Such investments are not so often analyzed by professional analysts and are ignored by largest investment funds. That opens some opportunities for small investors.
If you want to find some undiscovered cheap stocks that could increase in price many fold, then it is necessary to look among smallest capitalization stocks or penny stocks. To make it even spicier, such stocks should be from emerging markets. Of course, the risk of such investments talks about itself.
When investing in such stocks, financial analysis is the key. Before making investments in risky small market cap stocks, you should not forget to:
- Calculate valuation multiples (as P/E ratio, PEG ratio, EV/EBITDA) for the stock and compare it to the stocks of similar companies.
- Analyze financial statements of the company for at least three past years. Be sure about company’s solvency.
- Get known with company’s management’s track record. Who are they? Are they reliable?
- Get known what the other shareholders of the company are. Are minor shareholders treated fairly?
- Analyze what is market share of the company, how does it change over years. Are new important competitors not entering the market?
- Analyze the main risks of the company. What is the probability for those risks to get realized? What would be the consequences? It is not happening while you are buying the stocks?
- Analyze what factors have the most important influence to the company’s market segment. What are the prospects of the market?