small-cap stocks

What are small cap stocks?

The Most higher risk-tolerant and Aggressive investors are attracted towards small cap companies for investment in the hope of earning high returns. Recently I read an article “Smallcap stocks may continue to beat large-caps in 2021. Here’s why” on the Economic Times website. which made me curious to write an article on Small cap-Stocks. Which may help you to broaden the concept of small cap stocks. So keep reading it.

What are small cap stocks?

Small cap may be a term that consists of companies that are neither large-cap nor mid-cap. Small caps fall below the market capitalization of roughly Rs.5000 Cr. This classification can change with the changing of market valuation in a company. Market capitalization refers to the market price of a company’s outstanding number of shares available. However, the classification is additionally subject to a company’s rank within the benchmark indices like Sensex and Nifty. For instance, the businesses which are listed from 251st – 500th within the Nifty Index are generally considered small cap companies. Nifty also features a benchmark small cap index in India called the Nifty Small cap 50 which hosts the highest 50 most traded small-cap securities within the market

Small Cap Stocks 

Small cap stocks or small-cap equity are stocks of small cap companies that are publicly traded during a stock market. Investors, who want to get higher returns from their investments, tend to seek out small cap stocks as an appropriate option for them. Additionally, individuals who have a high-risk tolerance level and may bear exposure to plug risks may consider this investment option. These stocks are volatile in nature and are susceptible to market risks when the market goes through a correction phase. However, investors can avoid the danger factor related to small cap stocks by adding market-friendly investments in their portfolio by good quality stocks.

Features of Small Cap Stocks

 

Individuals who want to take a position in small cap stocks should study the following features –

Volatility: The Small cap stocks tend to be heavily influenced while the market fluctuates, These are highly volatile in nature. For example, During the high market phase, these stocks perform well but tend to underperform when the market is struggling.

The factor of risk: The dependence of small cap stocks on the market makes them vulnerable to its fluctuations. These stocks are more susceptible to be suffering from the market recession and take time to get over the same; this makes small cap stocks a risky investment option.

Returns: We all are well aware that the rate of growth of a baby or child is so much higher than an adult, Likewise the Small cap shares grow very fast. They are counted among the top-yielding investment options and are considered to possess the potential to emerge as multi-baggers by yielding over 100% returns.

Investment Cost: Besides the initial cost of acquiring small cap shares, investors even have to pay an annual charge called the Expense Ratio. The upper limit of those are the same is 2.5% of the average of AUM. Investors who invest in small cap stocks with rock bottom Expense Ratio would generate better returns from them.

Investment Horizon: Investors can invest in small cap stocks in India for both long-term and short-term purposes. However, investors should choose small cap shares that accompany an extended investment horizon to spread the risks related to them and also to get substantial returns.

Taxation: If the shares were held for less than a year, the gains generated by them are subjected to short-term capital gain tax at the rate of 15% because and the returns generated on such redemption of small cap shares are treated as income under Section 80C. However, gains generated from shares that were held over a year would attract long-term financial gain tax at the speed of 10%.

What should an investor check out while picking stocks during this collection of Small cap stocks?

Financial Strength:

This is one of the common criteria which Investors should check out before investing in any company. Generally, small cap companies don’t have as many sales as large-cap or mid-cap companies but if the company’s record is stable with decent cash flows and low debt, these companies can survive better relatively against their peers. So, the size of the business is not a matter. But investing in financially stable companies combined with a high potential to grow in the future is very important.

Top-Line & Bottom-Line Growth:

It is also important to see the past performance of small cap companies to find out whether the track record is decent in at least the last 5 years. For instance, check the company’s last 5 years Sales and Profit CAGR growth and compare an equivalent with its peers. This will offer you a thought on how that specific company has performed compared to its peers. A consistently making profit company grows its sales and eventually provides better returns to investors.

Market size & Positioning:

Generally, small cap companies are single product or single service line companies. It is important to understand the general market size of the business a corporation is working in, and also the presence of that company therein the market. A niche positioning in the market or some entry barriers created can make a significant difference to the company’s valuations. That will be the broader outlook on the positioning of the company in the market size of its business.

Management Quality & Commentary:

In every company, its Management plays an important role in choosing the company’s future. It’s better to scrutinize its management history and any possible lapses done by them within the past, Before Investing in a small cap company. As we see, tons of small companies and even some bigger companies fall prey to poor corporate governance and inflation of monetary statements. Also, avoid those companies which face legal/regulatory battles. Small cap companies tend to urge overwhelmed by such regulatory challenges and it’s best to avoid such cases.

Disclaimer: This article is written on the basis of my personal studies and experience for educational purposes only. I am not a financial adviser. So You are advised to consult a market professional regarding your investment to decide on the choice of the best investment option to bank on your capital

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