An Introduction to Small-Cap Investing

Put simply, small-cap stocks are shares in companies with small ‘market capitalisations’ – that’s the total dollar market value of the company’s shares. (You calculate this by multiplying the number of shares on the market, by the current price of one share).

What determines a small-cap stock can vary in interpretation, but typically on the ASX, it means companies that are valued at between $20 million and $200 million.

To put this in perspective, a large cap or “blue-chip” company is generally regarded as having a market capitalisation of over $1 billion dollars.

What characteristics define a small-cap company?

Companies in the small-cap market are responsible for breakthroughs in their sector for developing ‘game-changing’ technologies that have the potential to transform entire industries or are simply pioneers and risk-takers prepared to run with an idea.

It could be anything from a beaten-down stock whose strong fundamentals have been forgotten by a fickle market a tiny, off-the-radar firm developing a technology that could change their entire industry or a small miner sitting on a big mineral deposit that could send its share price up once word gets out

Find out which ASX small-cap stocks I think are primed for profit and completely overlooked by the wider market right now.

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What is the advantage of small-cap stock investing?

Basically – small-cap investing gives you exposure to the potential stars of tomorrow while they’re still available to buy for cents on the dollar.

This means for a relatively small outlay you can take a stake in a small-cap company and be rewarded with bigger than usual returns should the enterprise prove itself successful.

I’ve heard a lot about blue chip stocks but very little about small-cap stocks. Why is that?

Australia has one of the most highly concentrated stock markets in the world.

What that means is that most analysts focus their research of a small group of the biggest companies on the ASX. I’m talking about the big four banks, BHP Billiton and Rio Tinto, and Telstra and Woolworths.

Analysts and fund managers follow these companies closely, and as a result they grab the lion’s share of investment on the ASX. Outside the ASX 200 (the top 200 companies by their market cap value) analyst interest lessens dramatically.

Why? Well the big investment firms have billions of dollars to invest. And when they invest, they buy millions of shares at a time. But if the company they buy into is a small-cap stock, then the share price would fly through the roof with just one big order.

This immediately cuts into their potential profits, so a small-cap stock just isn’t a sensible way to play the market, when you’re a “big boy.” This also means most small-cap stocks fly under the radar.

And it leaves the field wide open for investors like you to find things out about small companies that the wider market doesn’t know!

With that in mind…

How are small-cap stocks different from blue chip stocks when it comes to making money?

As I’ve said, a glut of analysts and traders follow the large companies.

This generally means the market for ASX/200 stocks is “efficient”… and there are rarely any pricing anomalies you can pounce on.

But the small-cap market is chock-full of pricing anomalies hidden value and inefficiencies. This is where you, the private investor, can make big money, FAST.

Because if a small-cap stock starts to become successful in its business, it begins to get noticed by bigger investors. Its price/earnings ratio (P/E) gets re-rated higher, and that in turn gets reflected in a higher share price. And the investors who are already in on the stock before this happens will make a lot of money.

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What kinds of returns are possible from small-cap stocks?

When the wider investment community gets wind of a small-cap success story, the company’s stock price escalates very quickly… which is why they are so attractive – and exciting – to invest in.

However with great potential rewards also come a few risks .

Why are small-cap stocks considered risky investments?

The entrepreneurs behind small-cap companies are risk-takers themselves meaning their venture or business (for whatever reason) may fail and not come to fruition.

Often they are attempting to discover a new resource or bring to market a brand new technology – and most of the time these ventures are unproven. Sometimes they are never proven!

That’s why the price of a small-cap stock can just as easy fall as quickly as it rises, or even not move at all.

These aren’t stocks to invest your life savings in. They’re stocks to invest just a small part of your portfolio. In fact, when you punt on small-cap stocks you should only invest money you can afford to lose.

But if you pick the right stock you can make a big return.

Where can I find small-cap stocks and how can I buy them?

All small-cap stocks in Australia can be bought and traded on the ASX through your investment broker just like any other Aussie share.

How much money do I need to invest in small cap stocks?

The minimum trade you are allowed to do on the ASX is $500, so that’s really all you need to get started in small-caps (plus any applicable brokerage fees).

I go into these kinds of questions in a lot more depth and take you through an easy to follow, step-by-step guide into the exciting world of small-cap stocks in my starter handbook – The Investors Starter Guide .

This is a complimentary report if you choose to sign up to Australian Small-Cap Investigator today.

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Is a small-cap stock investment like a buy-and-hold investment?

This depends. But typically, speculating on small-caps by nature, means owning stocks for shorter time periods than you would blue chips.

Blue chips are for the long-term. With small-caps you want to buy them when they trading for cents on the dollar… and sell them when the wider investment community piles in sending the share price up.

Are there many small-cap stocks trading on the ASX?

Plenty! In fact right now there are about 987 stocks on the Aussie market trading for 20 cents or less. It’s incredible really… how stocks that only one year ago were trading for 80 or 90 cents are now trading for less than 20.

It really is a paradise to play in if you speculative investor and you know what to look for. So, the question is…

How can you determine a good small-cap stock from a bad one?

I’ll be honest… finding a great small-cap stock, worth risking your hard-earned capital on is no small task (which is part of the reason why your broker doesn’t bother with them!).

There’s no shortage of great companies and excellent opportunities at the small end of the ASX. But to sift the good ones from the bad takes a lot of work. You have to go through a company’s books, weigh up its ROEs and price/earnings ratios, checkout the management and the quality of their experience, chase up CEOs to verify stories, crunch the numbers in quarterly profit/loss statements until you see double… and that’s just the start!

To do it properly is a fulltime job. There are so many opportunities out there.

In truth, there are more dynamic firms than capable analysts in the Australian small-cap sector!

Fortunately for you, I’m one of those capable analysts and it’s my job to research them and tell you about them.

It might surprise you to see how my Australian Small-Cap Investigator track record stacks up against your broker’s performance.

If youd like to find out which small-cap stocks I think are primed for profit and completely overlooked by the wider market right now then

Take a 30-day no obligation trial run

of Australian Small-Cap Investigator

CALL 1300 667 481 NOW

Kris is also Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning .