We have a group of stocks that we refer to as “Small Cap.” They are defined as having a Market Cap of between $250,000 and $2 billion. Many are start ups trying to bring a new product or service to market. For example we are seeing many of the biotech stocks in this category. Many of them have a promising new drug but it first must go through rigorous testing by the FDA. This is a lengthy process involving several stages of testing, often lasting up to three years. Only a small group make it through. These become he new “stars” of the investing world and their stocks rise, often very quickly.
We find many differences between “Large Cap” and “Small Cap” stocks. The large caps are well established companies that have been in business over a longer period of time. They were tested through good and bad times and have survived. Most pay dividends. Trading in these stocks is very active, making it easy to buy and sell them. When it comes to media coverage, 80% of the news and stories you read and hear are about large cap stocks. Most mutual funds will include large cap stocks as their core holdings. Media coverage extends to stock analysts that specialize in one or more groups or sectors of large caps. These companies not only publish their earnings reports but, in most cases, give forward guidance concerning what their earnings will be in the next quarter and next year. What all of this means is that it is easy for investors to follow these stocks.
On the downside, because of all these factors, large caps tend to be fully priced. You don’t often see them doubling in price like some of the small caps.
The small cap group offers a greater potential for price appreciation. It is easier for a $10.00 dollar stock to double than it if for a large cap like GE. But with this opportunity comes much greater risk. Finding the right ones requires much research and diligence. First, it is difficult to get “hard” data on these companies. The SEC does require quarterly reports but that is pretty much the extent of it. Their websites often give out a lot of “fluff” on their potential for growth. One of the sectors that exhibits this is the Junior Mining Sector. Here we have small, start up mining companies, some of which only have leases on land that they claim have the great chance of finding minerals like gold and silver. Others have found mineral deposits but they are insignificant. Still others have the minerals in the ground but do not have the capital it takes to launch a full scale mining operation. Finding that one gem requires hours of painstaking research. The same is true for the biotechs. Many companies have a promising drug but fail to make it through the FDA’s clinical testing process.
As an investor in small caps, you are left pretty much on your own. However, if you enjoy this kind of investing and have the tolerance for the added risk it provides, then by all means add a few small caps to your portfolio.