Small cap stocks are very popular among new investors nowadays. In various aspects, small cap stocks differ from large cap and mid cap company stocks. There are several advantages to investing in small cap companies, as well as a few disadvantages to consider. If you are thinking about adding small cap stocks to your portfolio, here is a breakdown of what they are and how they function.
What are small cap companies and small cap stocks?
Companies in India that have a market capitalisation or market value of less than Rs. 5,000 crore are considered small cap companies. The stocks of such companies are called small cap stocks. Small cap stocks can be found in almost any industry, including healthcare, banking, and technology.
The top 100 companies selected based on average market capitalisation are classed as large cap companies by SEBI (the Securities and Exchange Board of India). Mid cap companies are those in the 101st to 250th positions. Small cap companies are those after the 250th position. SEBI updates this list every six months, requiring mutual fund companies to update their scheme portfolios.
Why should one invest in small cap stocks?
- Greater growth potential
- Less competition from institutional investors
- Better returns as compared to large cap companies
How to plan your portfolio with small cap stocks?
- Small cap funds should be preferred based on their long-term or year-to-year performance records. Generally, funds that outperform their large-cap competitors during both boom and downmarket cycles should be considered.
- Undertake risk assessment. If small cap companies are not supported by a significantly steady increase in earnings, it raises the risks. Investors should carefully analyse the companies/funds because the category is predicted to stay volatile.
- When evaluating small cap stocks, it is important to consider a few financial ratios like the Price-Earnings Ratio (P/E), Earnings Per Share (EPS), the Price-to-Sales Ratio (P/S).
- In any market cycle, one should not lose sight of quality. During boom periods, investors have been observed to move down the quality chain in search of larger returns. If the market starts to decline, this approach might be very risky, since it could cut out a major amount of the capital invested.
Small cap companies provide a tremendous upside owing to their growth potential that larger companies do not. These stocks are one such investment option that can turn out to be a multi-bagger if analysed properly. Yes, it is true that they are risky, but a retail investor can easily balance their risk by employing well-researched strategies and can consult a financial expert on the same.