What are small-cap stocks?

What are small-cap stocks?

Beginner

1st September, 10:14
Updated: 29th October, 16:59

Looking to invest in stocks of companies that are earlier in their growth cycle?

Investing in small-cap stocks could help generate good future returns if you make the right decisions. In this lesson, you’ll learn what small-cap stocks are, their key characteristics, and where to buy them. We will also provide you with examples of some of the top small-cap stocks right now.

What are small-cap stocks?

Small-cap stocks are stocks with smaller market capitalisations compared to more established companies. While there’s no hard and fast rule about small-cap classification, you’ll often see small-cap stock defined as those with a market cap of $300 million to $2 billion.

Why do investors look for small-cap stocks?

Many of the most successful stock market leaders of all time started as small-cap stocks. These stocks are often younger and offer a lot more room for future growth than established stocks, both in terms of earnings per share and stock price. It can sometimes be riskier to buy a small-cap stock than a large-cap because lower liquidity can lead to more volatility and thus bigger price swings. But if you buy the right small-cap stock at the right time, the potential rewards can be substantial.

What are the defining characteristics of small-cap stocks?

1) Small market capitalisation

Small-cap stocks can carry all kinds of characteristics, but the one immutable trait is that they hold a market capitalisation that’s smaller than more established companies. We mentioned before that small-cap stocks typically sport a market cap of $300 million to $2 billion, with anything smaller than that being considered a micro-cap, while the next level up is considered a mid-cap stock.

2) Larger-than-average returns

Small-cap stocks have proven to generate bigger price gains than their large-cap peers when the market moves in their direction. Think of finding a great small-cap stock as getting in on the ground floor, before the big mutual funds, hedge funds, and other institutional investors figure it out.

3) More volatility

Small-cap stocks typically trade far fewer shares per day than their large-cap contemporaries. That relative lack of liquidity makes them more likely to go through significant price swings – so while you can make money quickly with small-cap stocks, you can lose it just as fast.

4) They can be bought in bulk with financial instruments

If you’re looking to benefit from the upside of small-cap stocks but want to smooth out the potential volatility by diversifying your investment, you can invest in the Russell 2000. The Russell 2000 is the most widely followed index of small-cap stocks in the world. The S&P 600 is another popular small-cap index that offers the potential for solid price gains while enabling you to diversify your investment.

Here are some examples

If you’re looking to invest your money in small-cap stocks, here are some of the best options available today.

1) Magellan Health (MGLN)

For-profit healthcare companies continue to thrive in the United States, where they hold considerable lobbying power and an existing system of private health insurance to generate profits. Magellan is a managed healthcare company based in Phoenix, Arizona with a $1.9 billion market cap whose stock has more than doubled from its mid-March 2020 lows to early June 2020 levels.

2) Sonos (SONO)

Sonos is an audio products company that develops and manufactures smart speakers. With a $1.2 billion market cap, Sonos has also rebounded impressively from its mid-March lows, soaring nearly 60% from that point as of early June 2020.

3) Rambus (RMBS)

Rambus is an American semiconductor company whose stock carries a $1.8 billion market cap. A high-flyer during the tech rally of the late 1990s, Rambus’s stock hasn’t made much progress in the two decades since. The good news is that the stock has shown resilience following the coronavirus-driven market downturn, bottoming out in mid-March 2020 and rallying more than 70% in the two and a half months that followed.

4) Clearwater Paper (CLW)

Clearwater is a pulp and paper product maker that’s been rising fast since bottoming out in March 2020, increasing more than 140% from that point as of early June. Even after that big runup, Clearwater sports a small market cap of $546 million and plenty of room to grow.

How do I find small-cap stocks?

Websites such as MarketWatch and Yahoo Finance offer screening tools that enable you to search for small-cap stocks based on any parameters you like. But you don’t need to go anywhere; you can also find the best small-cap stocks right here, with our lists of top-performing small-cap stocks that we publish every month.

Visit this guide for more information on how to find small-cap stocks >

Now that you have a better understanding of small-cap stocks, simply click to go onto our next lesson about mid-cap stocks.

By Jonah Keri
Jonah Keri is a trader and analyst who spent 11 years at Investor's Business Daily covering the markets. He now writes about stocks, cryptocurrencies, and other investments for Invezz and about emerging technologies for private clients.
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