’Small Caps’ are generally companies with market capitalization values between $250 million and $2 billion.
Historically, small caps’ average returns have outperformed large caps. Small caps are usually new and small companies that have high earnings growth potential. Furthermore, because small caps are less followed by investors and analysts, they’re often in lower demand than larger companies. As a result, these companies are often undervalued. Thus, many small caps are potential value and growth stocks. However, greater return also comes with greater risk. Because these companies are young and small, they are much more vulnerable to economic downturns. They have limited assets on their balance sheet to protect them against hard times and thus are more likely to go bankrupt.
A well-diversified portfolio should not be full of small caps. Instead, investors should carefully pick a few small caps with high earnings growth rate, sound management, and great future prospects. On average, small caps have higher betas than mid and large caps, and investors need to fully understand the risks before investing in small caps.