Small-Cap Stocks: The Beginning of the Journey

When an individual investor wants to roll up his sleeves and do some research in the pursuit of the next big winner in the stock market, the place many start is in the small cap sector.

As with the other capitulation sizes (capitalization is a stock's market value), no one can completely agree on a precise definition, but corporations under $2 billion are often considered small caps. It should be pointed out that there are two asset classes below small caps. Micro caps are companies between $50- 300 million and Nano caps are below $50 million. To further confuse the issue, there are also "penny stocks" that really have nothing to do with capitalization size, but are stocks that trade very cheaply.

Life begins for many small caps as an Initial Public Offering (IPO) or as a "spin off" from a larger company. Like Toddlers, these companies are often still in their developmental stage. At this point they exhibit characteristics that give them the potential for both massive growth and extreme downside volatility.

Their huge growth potential is obviously the piece that attracts most investors. Who wouldn't have wanted to get in on a Microsoft in its early days of trading? The question of course is who knew about Microsoft back then?

Often, it is individuals not institutions that first get in on the ground floor. Analysts working for major brokerage firms usually don't have the time to develop coverage on small companies and institutional investors generally have limitations of how much they can own of a single company. Although a $100 million may seem a lot to an individual, it's a drop in the bucket for the big players and equals 20% of a $500 million company. The 20% far exceeds what the SEC stipulates a mutual fund can own and often exceeds the investment policy statement of an institutional investor.

The disadvantage here to the investor is there is relatively little published research that the individual can rely on in the decision making process. But the good news is that the individual investor has the opportunity to buy the stock before the institutions get in and run the price up.

Many investors believe in the "efficiency" of the market. This means that with all the information out on a particular stock, the market can "efficiently price" any stock. In the case of small caps (where information is often lacking), an argument can be made that there is some potential to profit from inefficiencies in the market. Again, this cuts two ways. Many investors can remember that it wasn't too long ago that many small cap techs sold for vastly inflated prices only to watch a steep price slide as the market started to correct these inefficiencies.

Income investors should probably look elsewhere. Small caps generally conserve whatever cash they earn for growth potential. Any yield is usually incidental to their objective.

For mutual fund investors, small caps can be an interesting proposition. Certainly, mutual funds can help offset some volatility through diversification. However, for investors that want to follow a small cap's ascension to the large cap sector, mutual funds may disappoint. Often, to avoid what's called "style drift" a mutual fund manager sells a successful position simply because it has outgrown its capitalization value. While this may be helpful for asset allocation purposes, it's not appealing for investors wanting to watch a company "grow up".

Glenn ("Chip") Dahlke, a senior contributor to the Living Trust Network, has 28 years in the investment business. He is a Registered Representative of Linsco/Private Ledger and a principal with Dahlke Financial Group. He is licensed to transact securities with persons who are residents of the following states: CA. CT, FL, GA, IL. MA, MD. ME, MI. NC, NH, NJ, NY.OR, PA, RI, VA, VT, WY.

If you have any questions or comments, Chip would love to hear from you. You may contact him at dahlkefinancial@sbcglobal.net. You may also reach him by going to the Living Trust Network web page located at http://www.livingtrustnetwork.com.

Copyright 2005. LivingTrustNetwork, LLC. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed without the written consent of the Living Trust Network, LLC.

---

What is the Most Important Indicator of All?

Most stock market traders have a favorite technical indicator.The one... Read More

Fools Gold

The stock market has been in an up trend for... Read More

Cash Is A Position

I go to the Money Show every year to visit... Read More

How Much Money Can I Make With Trading? What Account Size Do I Need To Start?

What account size do I need?How much money can I... Read More

Stock Chart Reading

As an investor you will want to check out any... Read More

Investing in the Stock Market - When To!

Is really not as important as to how you invest... Read More

Ignore Stock Market Talking Heads

You should ignore analysts on TV, the radio, the newspaper... Read More

Low Tide

When you stand on the ocean shore and watch the... Read More

How To Be A Winner

Everyone who invests in the stock market wants to be... Read More

Stock Trading - Daddy, Why Arent We Rich?

One Saturday morning, while he was sitting at his computer... Read More

Oil Stocks As A Long Term Investment

The demand for world oil is increasing while world reserves... Read More

Shorting Stocks ? The Basics, Part II of II

After the publication of the first part of this two... Read More

Successful Trading ? Establish Your Risk Level

Before you embark upon a journey of trading stocks or... Read More

Trading For A Living - Part 1

There can't be many traders who haven't at least considered... Read More

Your Job

There are so many kinds of work that needs to... Read More

Hedge Fund Advertising

Have you seen all those big full page ads for... Read More

Duck

Duck! No I don't mean a quack, quack. I meant... Read More

Lies, Damn Lies and Mutual Fund Returns

How many times has this happened to you? You're at... Read More

Buying New Issues

Has your broker been calling you recently with the "great... Read More

Wall Street Paradigm

In 1960 an engineer working for a watch company in... Read More

The Importance of Using Stop Loss Orders When Spread Trading the Financial Markets

A Guide to Using Stop Loss Orders Stop losses are... Read More

Alfred E. Newman

What! Me worry?Many of you remember the cover of MAD... Read More

Option Trading Basics

Options trading can increase the profits you make when trading... Read More

The Stock Market - Part 1: Believe It Or Not, Its Always Been Your Best Friend And Always Will Be

Regardless of the fact that the world's stock markets have... Read More

The Elephant

Four blind men were asked to give a description of... Read More

Frog In The Pot

You remember the story about the frog that was put... Read More

NASDAQ 800?

In November of 2000 when the NASDAQ was trading at... Read More

Humpty Dumpty the Stock Market Falls Down

Humpty Dumpty had a great fall and all the King's... Read More

Picking Mutual Funds to Outperform the Market

With over 6,000 mutual funds available, it may be tempting... Read More

Inertia

One of the basic laws of physics is that a... Read More

Making Outsized Returns in the Stock Market - Using the Dow Theory

The Dow TheoryCharles H. Dow... Read More

Will the Stock Market be Lower in October?

The stock market often closes a week in the middle... Read More

Hedge Funds: the Good, the Bad, and the Ugly

Alfred Winslow Jones started hedge funds in 1949. He was... Read More