How To Find Small-Cap Stocks

Have you been thinking about breaking into the small-cap market? You might be wondering “How do I choose a small-cap stock?” Maybe the thought of investing in a notoriously volatile market is daunting. But don’t worry—there are many things you can do to up your chances of investing in a profitable small-cap stock. The key is doing thorough research. Follow these research tips to find out the best small-cap stocks.

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The Research Tips You Need To Know

Small-cap stocks are some of the most volatile stocks on the market. They come with a significant risk of losing money. Because small-cap companies do not have the same financial security and resources as larger companies, when financial hard times ensue, small-cap companies are at greater risk of crumbling or going bankrupt. This greatly affects their stock price and could leave you with hurting pockets. Additionally, they have dramatic price swings, and often fluctuate about 5% or more in a trading day.

Although this might be enough to scare away some investors, small-cap stocks can also bring investors very large rewards. The great thing about small-caps is that they are in the expansion phase, meaning that they have not yet reached their market cap. Statistically, they have outperformed large-caps throughout the years. Investing in a small-cap means you could be investing in the next huge, multi-billion dollar company that could bring you significant returns. Some of the world’s biggest companies, like Apple and Amazon, started out as small-cap companies and are now global giants.

To dip your toe into the vast lake of small-caps, you’ll need a bit of elbow grease. Proper, thorough research is paramount to successful small-cap investing. Here are our top tips on how to find small-cap stocks:

Lookout for Any Market Shifts

The first thing to do when looking for a potential small-cap to invest in is to analyze the market and try to recognize any market shifts or trends. For example, is there something going on in the world that might need a new, innovative solution? Is there a company that has the solution to a niche issue? Investing in these types of companies could bring in large returns. For instance, a couple of decades ago, there was a shift from CD to DVD format. All of a sudden, many companies were in need of software to facilitate this transition. There happened to be a handful of small-cap companies that had the software to meet the needs of those larger companies. Through this, these small-cap companies grew significantly. This is how an undervalued small-cap stock shoots up and makes its investors big returns.

Some industries to pay close attention to are the green technology, medical, and cannabis sectors. Investing in companies that thrive under new and emerging trends and have the solutions to upcoming issues are the ones that can potentially rake in the profits.

Know the Type of Market to Invest In

Small-caps have often outperformed their larger counterparts. However, be cautious of the type of market you choose to invest in. Small-cap companies outperform and do well in young bull markets when the economy is on the rise, or recovering from a recession. While it takes a very strong stomach, the most successful small-cap investors are actually buying small-caps when prices are depressed during bear markets, and selling during a bull market when prices are inflated.

Look at the Numbers

When it comes to small-cap research, there is no cutting corners. You must do your homework and really look into the potential promising small-caps. Really delve into the numbers: look at earnings reports, past growth, financial documents regarding the company, press releases, and growth projections. Because small-caps do not have a lot of financial analyst coverage due to their size, this could prove difficult, but there are platforms that small-caps publish their financial information on.

Once you do find access to a small-cap’s financial information, one of the biggest things to look for is revenue growth of 20% or higher. This is an indicator that the small-cap has been performing well and could continue to perform well into the next quarters. If you see small profit margins, do not be discouraged. Because small-caps are in the expansion stage, they do not tend to have large profit margins. In fact, most small-caps struggle to reach profitability at all, so earning a profit, even if small, is considered a promising achievement for a company of this size. Other things to consider when researching the financial aspect of your small-cap are:

  • Past price appreciation
  • Price-to-earnings ratio 
  • Price-to-sale ratio
  • Total addressable market
  • Optionality

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Keep This In Mind

While small-cap stocks are very volatile and not a sure-fire way to make you rich overnight, it is still worth considering investing in them. Doing proper research like analyzing market trends and shifts, investing during or before a developing bull market, and looking at the financial performance and history of the small-cap you choose can greatly increase your odds of success. Regardless, you want to make sure your portfolio is diversified, meaning that you are not just investing in small-caps, but also large-cap, blue-chip stocks. Having a diverse portfolio could help you offset any losses that you might incur when investing in small-caps.

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