A small stock is a publicly-traded company with a market capitalization range of $300 million to $2 billion. Although trading small-cap stocks have over the years received a bad reputation, it has led to the development of leading brands in the trading industry. There has also been confusion between penny stocks and small cap stock, and people often use the two interchangeably.
However, these two are quite different from their formation to the code of operation. Penny stocks are based on trading on low prices and market capitalization while small-cap stocks trade on market capitalization of the company.
Calculating Market Capitalization
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Market capitalization is the market value of the company’s outstanding shares. Its calculation is quite simple, and all you need is to have the current share price and the number of outstanding shares. The calculation has a formula that is common and widely used by investors in the business sector, which is:
(Current share price X number of outstanding shares) = Market capitalization
For instance, we assume company Y has 30.08 million outstanding shares, and the current price per share is $22.15. Calculating the market capitalization for company Y, you will basically multiply the variables above as in the example below:
($22.15 X 30.08 million outstanding shares)= approx. $666 million.
High Probability of Inefficiency in the Market
Compared to large and mid-cap companies, finding information on small-cap stocks is hard. The trading analysts give little to no attention to such companies, which paves a higher probability of improper pricing. Therefore, it creates a vast opportunity where investors can leverage market pricing inefficiencies to earn more returns in their investment. In other words, if you add a small-cap stock in your portfolio, you get higher chances of making high profits within a short investment period.
Prices Are Not Pushed Up by Financial Institutions
Major financial institutions often invest in any stocks to increase their profit margins. In return, this leads to an increase in pricing to that such institution’s benefit. However, when it comes to small-cap stocks, there are regulations that govern financial institutions, preventing them from investing heavily. This, therefore, guarantees that the prices will not be artificially pushed up due to major financial institutions’ investments.
Growth Potential
The majority of successful companies started as small caps. There are higher chances of growing and building your investment in small caps compared to mid and large caps. In small-caps, there is always an open opportunity to grow, and your investment is not equally monitored as compared to large or mid-caps. Since there is minimal supervision in small-cap stocks, there is a higher probability of growing rapidly and increasing your investment.
Conclusion
Although there are multiple risks and volatility of investing in small caps, its also a better way of enlarging your investment. Therefore, when you venture into small caps investment, ensure you have all your records straight and be aggressive. Lastly, keep in mind that it takes time for a small-cap stock to grow into its full potential.
