You have probably heard people saying that numbers don’t lie. When it comes to the stock market, small caps are known to do much better than large caps. If you master the art of selecting small caps, then you are a gem.
For the past 20 years, the S&P 600 has had a small-cap index of 10.5% in comparison to an annual return of 7.9% for the S&P 500 during the same period. That’s probably why most people often try to invest in small-caps compared to large-cap stocks.
However, selecting small caps is not a walk in the park. This is why most of those who try to end up investing in large-stocks because they don’t have a better option. The other problem is that you might select a small-cap but not the right one.
Below are some of the strategies in selecting the right small-cap stocks:
1. Follow the momentum
Rarely do we purchase stocks whose prices are falling. Whenever the prices of a stock go down, it is an assign that the business or company is undergoing structural challenges. You should always wait and see the direction that prices will take.
But don’t be shy to by stock when the prices shoot at once. As a rule of thumb, never buy stocks whose shares have dropped to a record low or whose shares are experiencing a downward trend. This strategy might sound simple but can save you from huge losses.
2. Invest in what you understand
One major mistake that most investors make is investing in stocks they have no idea about. Investing in a biotech company when you don’t have any scientific background is a dangerous move.
It is important to first of all investigate the company you want to invest in before purchasing their shares. Investing in a company that you know little or nothing about will make it difficult to predict when to purchase and sell your stock.
3. Invest in companies before they are noticed by institutions
This technique is also known as robbing the train before it reaches its destination. By doing thorough research, you can invest in a company before major investors come in. Most of the time prices of the stock are still low.
It is a good idea to invest in companies whose institutional ownership is below 50 percent. The idea behind this strategy is that as more institutions come, the price of the stocks will also go up.
4. Avoid huge loses
Small caps have posted great gains since 1995 compared to both large caps and mid-caps. To make it sound even better, small caps recorded 20 percent more than large caps between 2011 and 2015. This long term high performance shows why owning small caps is the real deal.
Nonetheless, it is important to note that large caps are less volatile than small caps. On the other hand, small caps are less volatile compared to emerging market stocks.
But as we can see from the Everblu financial review, this is not to scare investors but alert them about the volatility nature of small-cap stocks.