How to Invest in Small Cap Stock

Small-capitalization stocks represent companies with publicly trading stock outstanding that has a relatively small total market value, based on the market price of each share. No specific benchmark defines small market capitalization, but it is generally agreed that less than $2 billion in total market value qualifies as small cap. Many investors feel the low price of these stocks presents great opportunity for substantial capital gains. You can invest by picking the stocks yourself or buying a small cap mutual fund.

Individual Stocks

Step 1

Establish an investment fund that consists of money you can afford to lose. Small-cap investing involves high risk.

Step 2

Research potential small-cap investments by using stock filters provided by online brokerage firms, stock analyst recommendations, stock price charts and the companies' financial reports, which can be found in the Electronic Data Gathering, Analysis and Retrieval, or EDGAR, database of Securities and Exchange Commission disclosure documents.

Step 3

Pick companies that have a history of enterprise growth, strong financials and stable stock price growth.

Step 4

Ask your broker if his firm allows purchase of small-cap stocks. Some brokerage firms restrict trading in these stocks because of the high investment risk they represent.

Small Cap Mutual Funds

Step 1

Research the performance of small cap mutual funds. A well-managed fund performs consistently over time, in both strong and weak economies. Performance over five years is the minimum amount of time to establish a reliable record. Make sure the same portfolio manager who yielded the strong performance is still managing the portfolio.

Step 2

Compare the fees charged by the mutual funds you are considering. These can be found in each fund's prospectus, and online brokerage firms often have fee comparison charts in their mutual fund selection tools.

Step 3

Select a fund based on its industry specialization, past performance and fee structure. If you have questions, ask your broker for advice.

Tip

  • Mutual funds provide portfolio diversification, which limits the risk of investing in small-cap stocks. Since small-cap investing is risky, the added benefit of having a professional portfolio manager backed by the research capabilities of an institutional fund adds a measure of safety, particularly if you have little or no experience in financial analysis.

Warning

  • Small-cap stocks, commonly referred to as penny stocks, are issued by companies that are generally young or regional, and the small size of their market capitalization often means that trading in their stock is volatile or somewhat illiquid.

Photo Credits

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