Smallcap history. Many largecap companies were once smallcap, leaving many individuals today wishing they would have invested in them in the past. A popular example of this trend is Netflix. About 15 years ago, Netflix had a market cap below $1 billion, while today its market cap is over $125 billion.

Better returns? Within the S&P 500, the smallcap stocks, on average, have produced larger annual returns for investors than larger-cap stocks. To measure the performance of the smallcap companies in the Russell 200, two ETF’s can be used to compare their results. When comparing the iShares Russell 2000 ETF and the SPDR S&P 500 ETF, investors can see that smallcap stocks of the Russell 2000 performed better than midcap to largecap companies in the S&P 500, by an average of 2% per year for nearly 20 years.

Faster growth. Smallcap companies have the potential to grow faster and possibly larger than already established companies that see steadier growth that typically depends upon huge innovation or funding. A smallcap company can double in size quickly, unlike a largecap company that would take much longer. Investors may see larger returns at a much faster rate.

Under-recognized gems. Another point to address about smallcap companies is that they often do not receive sufficient coverage. The large players in the game cover headline news and pull the large investors. With so little coverage, the stock price could be improperly priced, therefore leaving the door open for a potential profit opportunity. Investors may go out of their way to seek out these companies and keep up with their developments as there may be something big on the way that no one is covering yet.

Less stable. Compared to midcap and largecap companies, smallcaps are typically less stable as they have not had time to mature and reach their growth potential. Their cash on hand is typically a lot less than a well-developed company. Overall, a smallcap’s outlook is more uncertain as investors have to keep a steady eye on key developments and research reports to better inform their decisions. Many of these companies fail within the first few months to years.

Smaller customer base. Smallcap companies are typically known locally and serve their community, which means they have not reached the broader audience and therefore the outlook on expansion for them is slim. When comparing a local shop to giants like Wal-Mart or Target, many investors and individuals with limited funds in their portfolios prefer the “safer” investments over smallcap companies.

Volatility. Smallcap companies are more prone to fall in volatile market conditions. With their small size, it takes less volume to drive the price in either direction. These small companies typically rise and fall around 5% per day, which presents a level of portfolio volatility most investors do not prefer.

Time consuming. As mentioned, smallcap investing takes a lot of time and research if done as safely as possible. Since many of these companies are fairly new, they do not have published financials on hand for investors to track trends. On average, these companies receive such little coverage, so not much is available to view online without some digging

Investing in a small to microcap company comes with its baggage, as do all investments. As seen throughout financial history, many large and profitable companies emerge from being a small cap company, just as Netflix did. Once they get so large, it leaves investors wishing they had seen it coming first. However, targeting these hidden gems requires a high risk tolerance, as not all smallcap companies have large success stories. These companies are less stable due to their new presence because they have not had time to mature. When making the decision on whether to invest in small & microcap, it comes down to the wants and needs of the individual investor.

Sources:

https://finance.yahoo.com/news/invest-small-cap-stocks-162300433.html, Todd Cambell, The Motley Fool July 31, 2019

https://www.investopedia.com/investing/introduction-to-small-cap-stocks/, Troy Segal June 25, 2019