Pros And Cons Of Smart Cap Stocks

Have you ever wondered what the experts mean when they talk about investing in smart cap stocks? Simply put, smart cap stocks means smart investing in small cap and micro cap stocks. For the sake of convenience, it is collectively called as smart cap stocks.

So what are small cap and micro cap stocks? Small-cap stocks are stocks whose total capital value ranges from $250 million to $2 billion. Micro cap stocks are stocks that have a market capitalization of less than $250 million. The main difference between smart cap stocks and penny stocks is that penny stocks are worth less than $1 whereas many of these smart cap stocks can be more than $1.

Although smart cap stocks can be traded on any stock exchange, they are mainly listed in NASDAQ and Over-the counter(OTC) exchanges because of the lenient listing rules in these exchanges.

Advantages
Though smart cap stocks are not given their due attention, this does not mean they are poorly-managed companies. There can be many undiscovered gems in this lot. The advantages of smart cap stocks are:

Growth potential: Small companies have more potential to grow when compared to large companies. The giants of today like GE, Microsoft and Walmart have all evolved from small start-up companies. These smart cap stocks can double in value when the company does the right things.

Opportunity for individual investors: Mutual funds are institutional investors who tend to buy shares worth hundreds of millions of dollars. They usually do not buy shares in small companies because these companies do not have much market capital. So, this is an opportunity for individual investors. The institutional investors will buy these stocks only after they have grown to a substantial size. If the individuals can get in early, then they can reap huge profits.

Improper pricing: Most of these smart cap stocks, because of their small market capitalization, do not get much attention from Wall Street. When they are so under-reported, there is a high possibility that they may be priced improperly. More often than not, they are under-priced. These companies will be worth more than the price at which they are traded. Individual investors can profit from these discrepancies.

High Rate of return: The huge growth opportunity available for these smart cap stocks enable them to give very high rates of return over a period of time. The table below from Morningstar and money-zine throws more light on the growth and rate of return of smart cap stocks:
Stock Type 3 yr return 5 yr return
Large Growth stocks 9.00% 10.33%
Mid-cap Growth 11.15% 13.88%
Small Growth 8.25% 13.26%
Large Blend 8.65% 10.70%
Mid-cap Blend 9.00% 13.97%
Small Blend 7.04% 14.06%
Large Value 8.25% 11.52%
Mid-cap Value 8.46% 13.99%
Small Value 5.34% 13.23%

From the above table, we can infer that small stocks tend to give higher rate of return over a longer period of time. This reflects their growth potential.
Disadvantages

Smart cap stocks have their negative side too. The disadvantages are:

Higher Risk: The primary disadvantage is the high risk associated with these stocks. They are expected to grow well, but sometimes, they may not have the required capital to weather big storms in the market. This is a flip side to smart cap stocks.

Time and Energy: It requires a lot of time and energy to identify these stocks. They are not easy to find and a lot of research is required.

Lack of information: There may not be enough information available about these companies' earnings and forecasts. Media and most of the investors are concerned only about the big stocks and so these small companies will be mostly ignored.

In spite of its disadvantages, the right smart cap stock companies have a huge growth potential and this in turn will give big returns on capital.