Investors would agree: portfolio diversification is important. And what better way to increase diversification than investing in small-cap stocks? The truth is that, when invested in during the right time, small-caps can really be a phenomenal investment and a great addition to your portfolio.
The success of your small-cap investments truly depends on many factors. One of the most important factors includes the time at which you invest in small-cap stocks. These stocks are very influenced by bull and bear markets, so correct investment time is paramount. Read on to find out when the best time to invest in small-cap stocks is.
What Are Small-Caps?
Small-caps are companies with a small market capitalization ranging from $300 million to $2 billion. They are primarily characterized by volatility in the form of high returns or great losses. Their volatility can be worrisome to some investors, especially since small-cap stocks can fluctuate dramatically throughout the day.
The reason small-cap stocks are so volatile is that they are in their expansion phase and are easily impacted by outside factors. When companies are in their expansion phases, they typically have slim margins and insufficient resources to bolster them if a crisis were ever to occur. Even the smallest dip in the economy can cause a small-cap to struggle, or even go bankrupt.
Although the expansion phase makes small-cap companies a precarious investment, it also holds the potential for high returns. The same factor that makes them so susceptible to economic downturns is what can make them so successful in the right conditions. So while small-caps have little resources to support them, they also have a lot of room for expansion and growth. This means that they can increase their value by double. It is much easier for a small-cap company to jump from $1 billion to $2 billion. When companies increase like this, their stocks shoot up. You do not see this same growth in large-cap companies like Walmart or Apple.
All companies started as small-cap companies. Even global giants like Apple and Amazon once had a market cap of less than $1 billion. The possibility that you could be investing in the next big thing is what makes small-cap investing so enticing. Of course, to up your chances of investing in a company that will shoot up, proper research is needed.
Knowing The Right Time To Invest (And Other Tips)
Small-cap investing could be highly lucrative. To increase your chances of investing in a successful small-cap, there are some steps to follow.
Step 1: Invest At A Good Time
Investing in small-cap companies without giving a thought to the time and type of market could lead to a failed investment. This is why the first step in investing in small-caps is to analyze the market your in. There are two types of markets to consider: a bull market and a bear market. A bear market is characterized by prolonged price declines in stocks. A bull market is the direct opposite and consists of upward-trends, meaning that the market is rising. The general consensus is that investing during a bear market is more dangerous. This holds true for small-cap stock investing as well.
The best time to invest in small-caps is during a young bull market when the market is just beginning to strengthen and improve. Because bull markets are characterized by upward trends and little financial turmoil, small-cap companies typically do well in bull markets.
Step 2: The Importance of Market Shifts
Once you know if the market you are in is optimal for investing, the next step is to analyze the market for any potential shifts. Market shifts are when a new problem arises that requires a solution that is not readily available. When a new shift typically means that new services might be required. And for those companies that foresee the shift and have the needed services available, the payoff could be huge. This means that if you invest in a small-cap that has the potential to provide a much-needed service, you could make big returns.
An example of this is when a couple of decades ago, there was a shift from CD to DVD format. A lot of companies were not prepared for this shift and did not have the software to facilitate this change. What this meant is that the few companies that did have the software were suddenly hot commodities. They had a rare service to a large-scale problem, allowing them to grow and shoot up in value. The stockholders of these companies made large profits.
This shows that looking for market shifts before they happen can help you make a lucrative small-cap investment. When the shift begins or a problem/service/need begins to trend, the price per stock of those companies that can offer the right service increases. To look for new trends and shifts, analyze different industries and stay updated about nascent developments and news. This could help you foresee new trends. A couple of industries to keep your eyes on are the medical, cannabis, or technology industries. Some of the fastest-growing industries are centered around healthcare and computer systems design; they are projected to grow immensely within the next ten years.
Step 3: Take a Look At The Numbers
The final step in properly investing in the right small-cap is to do your research into the company’s past financial records. This can help you invest in the right small-cap companies. When looking at the company’s numbers, you should study any and all financial information you can find. This is important because past performance is a good determinant of future success. Revenue growth of over 20% is a promising characteristic of small-cap. When looking at the company’s past, you might notice small profit margins—this is typical since they are still expanding. Other factors to look into include:
- Price-to-earnings ratio
- Price-to-sales ratio
- Past price appreciation
- Total addressable market
- Optionality and versatility
Do not be discouraged if this information is not readily available to you. Small-cap companies tend to have less analyst coverage, making their financial information less known. It might seem like there is scarce information on small-caps at first search, but their financial information can typically be found on different platforms across the web.
So, Is Now A Good Time To Invest?
Ultimately, the time you choose to invest in is up to you. Knowing the market your in will help you make the right decision, and investing during a young bull market is always best. Take the time to analyze the market you’re in and the characteristics of your potential investment to make the most promising investment. Click here to learn more about small cap edge and investment.