Caveats Associated with Small-cap Companies

There are several problems associated with small cap companies. First, share price of small caps are generally below $5 per share. Second, few analysts cover small-cap companies.

There is a consensus among most Wall Street investors concerning stocks priced below $5. The prevailing thought is that they are risky investments. Why has $5 been chosen as the cut off is a bit of a mystery. Nevertheless, a lot of small caps are priced below $5. In addition, the majority of small cap stocks are not covered by analysts, so locating normalized “clean” financial data and obtaining future growth estimates for small cap stocks can be challenging. Analysts start following a company when it has met certain market capitalization criteria. Most small caps are ignored by analysts until they become mid caps.

These two caveats limit the field of potential small cap investments. This does not mean they should not be pursued. This means the number of small caps covered by analysts, priced above $5, are rare. Fortunately, there are mid caps and large caps that act like small caps.

As the successful small companies grow and the share price appreciates significantly above $5 per share, analysts take note. The share price will continue to grow until the earnings growth subsides. The best-case scenario involves buying great small cap companies and sticking with them for a long time. The second best scenario involves investing in mid-cap or large-cap companies that have grown and are predicted to continue to grow like a well-managed small cap.

A truly diversified portfolio will contain a variety of stocks that reflect different industries and market capitalization. Invest in the small caps when you find them. Balance your portfolio with successful mid- and large-cap companies that are managed well.

Our search for high-yield growth companies is narrowing. We know size is an important parameter in determining growth potential and we know it is wise to consult an independent stock analyst for future growth rates. Our last, and probably the most influential growth driver, is management. Who is the captain of this boat and where is it going?