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What are Small Cap Stocks?

Justin Bartz
Justin Bartz

Small cap stocks are securities that represent investments in companies that have a small market capitalization. A public company's market capitalization equals the price of one share of its stock multiplied by its number of shares outstanding, which essentially is the number of shares that have been issued by the company and purchased by investors. Small cap stocks are popular among some investors who enjoy the challenge of finding these small companies' stocks that someday could become blue chip stocks.

There is no official definition for small cap stocks, but they generally are considered to be shares of companies whose market capitalization is between $300 million US Dollars (USD) and $1 billion USD. Mid cap stocks are shares in companies with a market capitalization of $1 billion USD to $10 billion USD, and large cap stocks tend to be for companies with a market capitalization of $10 billion USD to $200 billion USD. Some investors also use other classifications, such as mega cap, micro cap and nano cap for shares in companies that are very large or very small.

Man climbing a rope
Man climbing a rope

Many investors value small cap stocks because they provide an advantage over traditional mutual funds. Some mutual funds are unable to give small cap stocks a significant position in their fund. This is because they have restrictions that limit them from buying large portions of a company's outstanding shares.

Like any stocks, small cap stocks can be high-risk investments from which more conservative traders might shy away. They might not be for investors who prefer a safer, long-term investment over the increased volatility and potential of a stock. This might sound like the definition for penny stocks as well, but there are differences between small cap stocks and penny stocks. A penny stock is a stock valued at a small amount, usually less than $1 USD but sometimes as much as about $5 USD. Small cap stocks fall into this category of belonging to small companies, but small cap stocks have to do with the company's small market capitalization, and the term "penny stocks" refers to the price of individual shares.

No matter which definition is used to identify small cap stocks in an investment portfolio, extensive research is necessary before they should be purchased. Investors must consider their objectives, their ability to take on risk and all charges and expenses before investing. Small caps often have high volatility and potential for a higher potential return on investment, but they also tend to have higher risks with the potential for greater losses because they have less stability and more price fluctuations.

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