In a world where bigger is better, an ambitious physician investor may be tempted to head straight for large-cap stocks without giving small-cap stocks a second glance, but this would be a mistake. As financial advisors have reminded us time and time again, the prudent and successful investor strives for diversification. That includes companies great and small.
A company’s market capitalization, which is the price of a company’s stock multiplied by the number of outstanding shares, determines how a stock is classified. As Motley Fool explains, small cap is short for small market capitalization, which specifically refers to a company with a market capitalization between $300 million and $2 billion. If a company has a market capitalization of less than $300 million, it is known as a micro-cap.
Small-cap stocks are generally known as riskier investments than their large-cap or mid-cap counterparts, but that doesn’t mean they should be discounted. Some of the strongest stocks on the market got their start under the small-cap designation. Have you ever heard of a little company called Amazon? Back when Amazon was an online book peddler, its stock was just $7.
According to StockMarket-Coach.com, the risk associated with small-cap stocks stems from the possible inexperience in the management of these smaller companies as well as limited access to funds. On the flip side, these unproven companies may also have huge potential for future growth.
Since none of us have a time machine, the best way to approach small-cap selection for your portfolio is by applying the same tried and true methods you would use to evaluate any stock. NASDAQ recommends that you stick to the basics. Check out the price/earnings ratio, shareholder information, analyst opinions, and the like.
You can also investigate mutual funds focused on small-cap stock to diversify even further. An index fund with holdings based on the Russell 2000 Index may be something to consider. Talk to your financial advisor about how to gain exposure in the small-cap market that will balance your portfolio without adding too much risk.