In the world of investments, there’s a term that is often used to refer to the summed-up value of all the shares that belong to a single company: the market cap. 

Furthermore, regarding the size of said company’s market cap, it can then be accommodated into one of the following categories:

  • If it is less than $300 million, it is considered a micro-cap company.
  • If it stands between $300 million and $2 billion, it is considered a small-cap company.
  • If it stands between $2 billion and $10 billion, it is considered a mid-cap company.
  • If it stands between $10 billion and $200 billion, it is considered a large-cap company.
  • If it is bigger than $200 billion, then it is considered a mega-cap company.

What does this knowledge represent for your potential venture into the stock market? Well, it depends. 

Regardless of what all the categories might have in common, their differences are just enough to make them all work in different ways. This is especially true when considering how you might make better use of them and whether you should even consider them as an option. 

For that reason, it can be of great value for you to understanding each category’s inner workings.

To assist you on this matter, let’s dive into the inner workings of the small-cap stock category.

What are small-cap stocks?

As stated earlier, small-cap stocks are stocks from companies with an overall value that falls between $300 million and $2 billion. In other words, companies with small amounts of market-cap.

Contrary to what many people might believe, a small-cap stock doesn’t necessarily mean a bad investment. In reality, investing in small-cap stock companies usually means that you are investing in younger companies.

And what characterizes a young company? Strong growth potential.

As time has already proven many times in the past, recognizing the potential of a small-cap stock could very well be the catalyst that sets you on a path to become a stock owner in businesses with market-caps of over $1 billion.

However, keep in mind that young companies also tend to be less stable than their more established counterparts. Depending on what risks they’re facing and how they plan to deal with them, your investment can either be highly profitable or a fruitless mistake.

That is to say, investing in small-cap stocks can be very rewarding, but not every small-cap stock grows as expected. To make sure your investment goes to a profitable company, you need to take a closer look at the company and the risks it’s facing.

How to evaluate small-cap stocks

As you might have guessed, probably the most important yet challenging part of investing in small-cap stocks is being able to find one worth investing in.

When looking for a young company with high growth potential, you should be looking for characteristics that reflect a disruptive company. Why? If your company is disruptive, it means that they’re willing to try new things to improve upon how they were once done. 

If your company is willing to take those steps forward, it has a higher chance of growing over time.

Here are some criteria to look for in any company that’s got your attention, so you can then better evaluate their current situation:

  • It has visionary leaders, willing to do things differently and create new opportunities.
  • It is willing to find entirely new markets and be ready to be the first to venture into them.
  • It has a notorious advantage over the competition.
  • It is of significant meaning and value to their customer base.
  • It rewards its shareholders with substantial returns.
  • It has high stock prices. (If that is the case, it serves as a confirmation of its true worth since other investors are also starting to see the company’s true value.)

Some small-cap stocks recommendations

Companies such as Carparts.com represent an excellent opportunity for you to invest in small-cap stocks. In this case, Carparts.com is an auto parts company that has recently gone through a change in management and a light rebranding. Its new leadership has striven for better technology, expanding territory and improving their web services. 

By now, it has already proven effective as sales have gone up during the 2020 pandemic and seem to be able to stay that way even after it ends.

An alternative would also be Yext, a company that ensures the information you see online about services you might need, such as restaurants and hotels, is kept up to date and accurate. It also serves as an example of a company that has significantly grown during the pandemic.

These examples showed varying degrees of the criteria established above. Again, try to look for them if you are researching individual small-cap stocks to invest in.

However, if researching stocks one by one isn’t your style, there’s also the option of using funds and ETFs that track small-caps. Here are some examples:

  • iShares Russell 2000 ETF
  • Fidelity Small Cap Growth Fund

Investing in small-cap stocks in 2021

As of the early 2000s, studies had consistently shown that small-cap stocks tended to outperform large-cap stocks on a long-term basis. 

In other words, if your efforts were to be focused on making longer investments (timewise), then you would have increased the possibility of your stock outperforming ones with bigger market-caps.

However, the pandemic indeed represented a non-calculated risk when it comes to newer and smaller businesses. Many had to shut down not long after first inaugurating.

Studies conducted in 2020 commonly showed that large-cap stocks were now outperforming small-cap stocks. This new-found information inspired many investors to opt for small-cap stocks to protect their portfolios.

However, by 2021 businesses have been better adapting themselves to accommodate the needs of a pandemic. In only the first months of the year, small-cap stocks have seen to be regaining their lost value and start to outperform large-cap stocks once again.

Why is this important to know?

If you’re interested in investing in small-cap stocks, you should be aware that small-cap stocks are a buy-and-hold type of stock. You should also be way more critical in your choice-making process because now you have to consider entirely new risks that come with the pandemic. That being the case, your research should also be way more profound.

Small-cap stocks are still a worthwhile investment, but you need to be better prepared for what they might represent for you.