Small Caps

Small caps are companies that are worth less than $1 billion in the market and more than $250 million. These delineations vary from brokerage house to brokerage house, and some are beginning to classify companies between $1 billion and $2 billion as small caps. But, for the most part, the upper limit still stands at $1 billion. A company's worth, or market capitalization, is calculated by multiplying the number of shares outstanding by the current stock price.

Small caps are small and usually quite volatile relative to their larger counterparts. They are often relatively young companies that haven't had enough time to establish a good reputation, or even a sustainable profit margin. Not only are small caps highly sensitive to factors such as management, quarterly earnings, and marketing, but prices can also be dramatically influenced by general economic trends, press coverage, unexpected quarterly earnings reports and other such market events. Any number of these events can cause a small cap stock to increase by several hundred percent in only a few months ~ or plummet to a fraction of its former value in a few weeks.

It's rare for small caps to offer an attractive dividend, because money often gets reinvested in the company to aid growth, and small caps are usually too young and unstable to be able to guarantee dividend payments for any significant length of time. Income stocks are usually found among mid caps and large caps.

Investors scouting for growth stocks and value stocks, and the chance to earn extremely high capital gains in a short amount of time, are drawn to the small caps pool. Fast profits are attractive, and it's fun to imagine winning big with only a little effort. But inexperienced investors should be very cautious when playing with small caps, taking extra care to establish protective stops to hedge against the significant loss that can come from a sudden downturn.

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