Small-cap stocks refer to companies that have a market capitalization between $300 million and $2 billion. These companies are often overlooked by investors because they are not as well-known as larger, more established companies. However, small-cap stocks offer big opportunities for investors who are willing to take on a little risk. In this article, we will discuss why small-cap stocks are worth investing in.
1. Greater potential for growth
Small-cap companies are usually in the early stages of their growth trajectories, which means they have a lot of room to expand their businesses. They are often focused on niche markets or innovative products and services that have not yet been fully explored. This means that if their growth plans succeed, investors stand to benefit from significant increases in the value of their shares.
2. Outperformance over time
Historically, small-cap stocks have outperformed larger companies over the long term. According to a study by Ibbotson Associates, small-cap stocks outperformed large-caps by an average of 2.5% per year from 1926 to 2017. This outperformance is likely due to the fact that smaller companies are able to adapt more quickly to changes in the market and are less burdened by bureaucracy and red tape.
3. Diversification
Investing in small-cap stocks offers diversification benefits to investors. Because small-cap companies are often focused on specific niches, they are less correlated with the broader market than larger, more established companies. This means that adding small-cap stocks to a portfolio can help reduce overall portfolio risk.
4. Undervaluation
Small-cap companies are often undervalued by the market. This is because they are not as well-known as larger companies and are often overlooked by investors. This presents an opportunity for savvy investors to buy into these companies at a low price and profit when the market eventually realizes their true value.
5. The potential for mergers and acquisitions
Small-cap companies are often targets for mergers and acquisitions. This is because larger companies are looking for innovative products, services, and technology that can help them stay competitive in their respective industries. When a small-cap company is acquired, investors who own shares stand to benefit from a significant increase in the value of their holdings.
In conclusion, small-cap stocks offer big opportunities for investors who are willing to do their due diligence and take on a little risk. These companies have the potential for greater growth, outperformance over time, diversification benefits, undervaluation, and the potential for mergers and acquisitions. While investing in small-cap stocks may not be suitable for every investor, it can be a powerful tool for those who are looking to build wealth over the long term.
