Get Large Gains out of Small-Value Stock

It is possible to get large gains out of small-value stocks if you do careful research and pick your stocks with care. There are a variety of reasons why smaller stocks are capable of generating large returns, including the growth nature of the stocks behind them, the lower prices they tend to trade at, and the heightened risk associated with them. While there are some drawbacks that should be considered, it is possible to increase your profits through these stocks.

What Is a Small-Value Stock?

While different definitions exist, small-value stocks tend to refer to small-capitalization (or small-cap) stocks. These are in companies whose total value would not exceed $2 billion if you were to add together the value of all the outstanding shares in the market. You should be careful to distinguish between small-cap stocks and penny stocks. Penny stocks trade for pennies or even fractions of a cent. The return possible in these stocks is enormous, but these stocks tend to be illiquid and very risky. They do not trade often enough that you can lock in a profit if you achieve one, and many of these companies go bankrupt. Stocks with a capitalization under $300 million are referred to as micro-cap stocks.

Big Growers

Small-cap stocks offer large returns because the companies that are this small tend to be at the growth end of the spectrum. You can make a higher return owning a stock that becomes the next hot thing than you can make in one that has already grown very large. Almost all large-cap companies were once small-caps but have become large and successful. The difficulty that you face is in picking which stocks will succeed and avoiding those that will fail.

Lower Prices

Although this is not always the case, you may observe that small-cap stocks tend to trade at lower prices. This can lead to larger returns. While it seems that this should not be the case, as you mostly care about percent return, there is a psychological trick that allows cheaper stocks to experience moves of bigger percentages. A stock moving from $100 to $120 seems like a more significant move than a stock moving from $5 to $6. Even though you have earned the same percentage either way, the move in the higher priced stock feels larger. This is the case in part because there are more stops along the way, but it is mostly explained by the feel.

Risks and Drawbacks

While it is true that you can earn large gains by investing in small-cap stocks, you can lose a lot as well. Smaller companies are more unstable and can experience rapid swings. They are less able to survive when times are tough. Finally, when investors perceive that the market is experiencing trouble, they may prefer larger stocks-–this is called a flight to quality. As with most investment opportunities, higher rewards mean you must take a higher risk to achieve them. This can be attractive, but you should do thorough research before committing any capital.

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