Be it investing (in small, mid or large-cap stocks), starting a weight loss program, starting your own business by leaving a high-paid job (Deutsche bank) or doing something when no one believes in you requires perseverance and trust in your hunches. But all these ideas are backed by intense researches, surveys, testimonies, experiences, degrees, internships etc. They are not just plain guesses that jump in your mind and guess what? Investing is similar to that. Before investing a rational person does the necessary research to maximize gains. In this blog, we will focus on the nitty-gritty of small-cap investing.
For the sake of clearing, concepts let’s first look at what small-cap stocks are-
Small-cap stocks are stocks of companies with a market capitalization of less than Rs. 5000 Crore. Such stocks are associated with poor liquidity and higher risks as they fluctuate faster in changing market scenarios. They perform poor in market lows and recover quickly in market highs owing to their small size. Many times, they lead the recovery herd and are undervalued. They are fairly priced; they are called small for a reason! Owing to higher volatility, they have high growth potential and can provide much higher returns than large and mid-cap stocks
But investing in small-cap stocks can land you into the category of a foolish investor.
Why?
Because they come with gargantuan risks and aren’t topping any charts. To put it differently, they’re a fairy tale waiting to be true, only if an investor does the correct amount of homework, researches the underlying business, macro trends and takes that giant leap of faith to invest.
But most individual investors don’t do their homework and call the ones who do ‘foolish’. When investor researches before investing, he is taking calculated risk which reduces (not eliminates) the chances of losses. It may feel like a high risk but then life IS all about risks. Every life decision isn’t foolproof, yet we take chances because it’s better to say ‘oops’ than ‘what if’. A calculated risk confirms investors risk appetite and provides them with an opportunity to create wealth too.
When you hold small-cap stocks people are going to call you stupid. But 20 years down the line when these stocks grow more than 10X the joke is on them. There are plenty of small-cap stocks that grew multiple times with time like Persistent Tech, Birla soft, Apollo hospital etc. All an investor needs to do is find them as every great company was once a small, undervalued business. Investors are advised to buy when no one is looking for them.
Few points to note while doing so are-
RESEARCH. A lot.
Finding small-cap stocks is like a treasure hunt where researching the business idea, balance sheet, financial ratios, leadership, management, trends of the underlying business pays. Stocks are like your students, the better you know about them (strength and weakness), the better results you give.
Look out for trends
To find small-cap stocks an investor can look for an idea that seems ahead of its time or ongoing trends like the Internet of Things, space, fintech, green energy, electronic vehicles, 5G, semiconductors etc.
Hold and lookout
After investing give your small-cap stock at least 3-5 years before you decide to cut it loose since they’re volatile. A big order here and there can shake quarterly profits easily. Hence don’t rush to sell them. During the lookout period continuously scan the market for changes, scan the balance sheet of the business and leadership periodically to decide if it’s time to say goodbye.
Learn from your mistakes
An investor can be wrong sometimes when investing in small-cap. It’s okay to lose a little. Even Warren Buffett makes mistakes! Make sure to improvise from losses to win at investing and life.
Take advantage of market timing
Since small-cap stocks are volatile they are often the leaders of a recovering market. Investors who want to take advantage of price fluctuations can choose to indulge in small-cap stock funds. But always remember that market timing as a sole philosophy isn’t lucrative. Risk equals higher returns, but calculated risk equals wealth.
Follow asset allocation
Invest only a part of your investments into small-cap stocks as they take time to grow and are volatile.
To conclude research well before investing anywhere to reduce losses.