When Bigger ISN’T Better
Dear Penny Stock Millionaire,
In terms of life and career, most people want to think big. But in the stock market, sometimes it pays off to think small.
When you purchase stocks from large, established companies, you may make profits over time. But it can take months or even years.
If you want to grow your account faster, you need to consider trading different types of stocks with greater volatility, since they can potentially offer a greater (and quicker) return. Small-cap stocks are one such option.
Small-cap stocks offer you the opportunity to invest in growth companies and potentially earn profits. Over the next few days, I’ll introduce you to small-cap stocks, including what they are, how to find them, and how you can benefit by trading them.
What Are Small-Cap Stocks?
No, we’re not talking about hats for small heads here. The cap in question here is the market cap, or market capitalization.
Market cap is an important metric for traders. It refers to the total market value in dollars of a company’s shares outstanding.
Market cap is used to determine the size of a company, versus just looking at sales or total assets.
Figuring out a market cap is extremely easy, even if you failed high school math. All you need to do is multiply the company’s total number of shares by the current share price.
So, say a company has 1 million shares, which are being sold at $5 each. You’re looking at a market cap of $5 million.
Once you figure out a company’s market cap, it can help give direction to your technical and fundamental analysis.
Determining the market cap can be a helpful method of filtering stocks of interest. It can also help you choose stocks from companies of various sizes, which can add diversity to your portfolio.
Now that you understand market cap as a concept, what is a small-cap stock?
How Small Is Small-Cap?
Depending on the market cap calculation, companies will fall into various size categories, ranging from micro or nano-cap stocks (this category would include penny stocks) to small, mid-cap, and big/large and even mega-cap companies (like Amazon).
In terms of size, a small-cap company would be considered one that falls between $300 million and $2 billion with the market cap formula.
If that sounds pretty large, that’s because it is. However, consider the fact that a mega-cap company might have a market cap at $200 billion or higher. Compared to a big and established company, the small-cap company is small potatoes.
Small-Cap Stocks vs Large Cap Stocks
What does the market cap size actually mean, though?
Where a small-cap company would fall between $300 million and $2 billion with the market cap formula, a large-cap company would be considered between $10 billion and $200 billion.
That’s a pretty big jump in size. But that’s not the only difference. Here are some of the important differences between small-cap stocks versus large-cap stocks:
Large-cap companies are not going to be up and comers. They’re established. Either they’ve been around for a long time, or they’re part of major industries.
Large-cap companies are generally recognizable to most people. Walmart, Disney, and General Electric would all be considered large-cap companies.
Considered stable and secure, the stocks offered by these companies tend to deliver long-term and reliable but slow returns. Investors can enjoy returns and dividends.
Small-cap companies are typically far less established than large-cap companies. This might be because they are a newer company, or they might be companies within up-and-coming industries.
Rate of Return
As opposed to large-cap companies, small-cap companies can potentially provide a quicker rate of return. However, this can come with a higher level of risk.
Why? Because they’re still growing. For example, it’s possible that a small-cap company went public fairly quickly, hoping to raise money. The issue is that this doesn’t give them a long log of financial history that you as a trader can research and evaluate.
Without much data, it can be harder to determine trends and patterns within the stock’s movement. This can throw a wrench in your stock research.
Depending on the time of year, small-cap and large-cap stocks may perform differently.
While small-cap stocks generally have a higher growth rate, they may not perform stronger than large-cap stocks all year round.
Small-cap strength can be stronger early in the year, possibly owing to what is called the January Effect.
The January effect is a phenomenon where buying is at all-time highs after the holidays. This follows a massive sell-off in December when lots of traders are selling off loser assets so that they can write them off come tax time.
Optimism is high in the new year, and many traders are willing to get in and try new things and invest in newer companies.
However, small-cap stocks can weaken as the year progresses. In the later quarters, it’s the stalwart large-cap stocks that tend to be strong. They’re less likely to be sold off during the December sell-off streak because they don’t tend to lose value.
The Bottom Line
If you aren’t a penny stock trader like I am, but you want to start diversifying your portfolio and including stocks with more volatility, small-cap stocks are a great place to start.
Now you have an understanding of what a small-cap stock is, what differentiates them from a large-cap stock, and their risk and rate of return, we can dive into the nitty gritty details.
Tomorrow, I’ll go over the benefits of trading small cap stocks, and why you should consider adding them to your portfolio in depth, so stay tuned!
Editor, Penny Stock Millionaires