The Appeal of Small-Cap Stocks: Opportunities for Growth

The Appeal of Small-Cap Stocks: Opportunities for Growth

Small-cap stocks may hold the potential for growth over the long term. Get to know the art of investing in small-cap companies in the financial markets.
15 Dec, 2023 07:19am
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Investing in the stock market requires the precarious art of balancing risks and rewards. If you are a fairly conservative investor, you may prefer investing in large-cap stocks or blue chip companies. These stocks may not have a high potential for further growth, but they are stabler and safer. 

 

On the other hand, if you are comfortable taking on higher levels of risk if it means potentially higher rewards, investing in small-cap companies may be a suitable course of action. 

 

What are Small-Cap Stocks?

One of the most important financial metrics used to evaluate a company is its market capitalisation. Simply put, this is the total value of all the outstanding shares of a company. In the case of a listed company, the market cap can also be defined as the total value of the company’s publicly traded shares. 

 

The stocks listed in the Indian financial market can be broadly divided into three categories based on their market capitalisation — large-cap, mid-cap and small-cap stocks. Small-cap stocks in the Indian stock market are the shares of those companies whose market cap is Rs. 5,000 crores or less. 

 

These stocks and the companies they belong to have certain key characteristics, as outlined below:

  • A high potential for future growth
  • Vulnerable to market fluctuations 
  • Highly volatile prices
  • Better suited for a long-term investment outlook

 

Tapping Into Growth Opportunities with Small-Cap Stocks

One of the most defining features of small-cap companies is the potential for growth that they possess. This is because of their relatively low market capitalization. After all, it is easier for an Rs. 100 crore company to grow to twice its value than it is for an Rs. 1 lakh crore company to double in value. 

 

This effectively means that such stocks may be able to generate significant and often benchmark-beating returns. In fact, investing in small-cap companies that have the possibility of becoming multi-baggers may sometimes deliver returns of 100% or more too. 

 

For instance, in April 2023, several small-cap Indian stocks recorded over 100% increase in their share prices. WS Industries saw its share price rise by over 125% during the month, while IB Infotech’s share price increased by 130%. The primary appeal of small-cap shares lies in such massive price changes, which can lead to significant gains for shareholders. 

 

The Flip Side: What Risks Do Small-Cap Stocks Pose?

While there’s no denying the growth opportunities with small-cap stocks, there are also some risks that you need to be wary of when you invest in these stocks. The biggest risk, perhaps, is that small-cap shares are extremely vulnerable to market swings and volatility. When the market performs well, these stocks may offer benchmark-beating returns. 

 

However, during market downturns, these stocks may be at a higher risk than large-cap stocks, which are relatively stabler. So, before investing in small-cap companies, you need to account for this risk and ensure that you can withstand such volatile price changes. 

 

How to Include Small-Cap Stocks in Your Portfolio?

Small-cap stocks can be value stocks, growth stocks, or even dividend-paying stocks. Depending on your financial goals, you can choose small-cap companies that align with your requirements and targets. Furthermore, you can invest in these stocks in any of the following ways:

  • Directly purchasing the shares of small-cap companies
  • Investing in small-cap index funds
  • Investing in mutual funds that focus on small-cap companies 

 

Conclusion

As with all segments of the stock market, small-cap stocks also carry both risks and rewards. If you want to tap into growth opportunities with small-cap stocks and include them in your portfolio, you need to have an actionable investment plan in place. The trick is to minimise the risks while maximising the rewards, so you can benefit from the growth potential of promising small-cap stocks.

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