Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

What is a Small-Cap Stock?

How many times have you heard someone say something along these lines: "I wish I had bought Wal-Mart 20 years ago," or "I'm looking for the next Microsoft."

It's easy to share that sentiment, as well as the frustration of not being able to spot future bellwethers when they are still in their early growth stages.

Of course, some farsighted investors did see the potential of those two blue-chip companies and bought them long before they became household names.

In November 1980, Wal-Mart (NYSE: WMT) was trading at a split and dividend-adjusted price of $0.01 per share. The stock has skyrocketed about 5,000 times in value since then, meaning someone who invested a modest $1,000 in the up-and-coming retailer back then would now be a millionaire several times over.

Meanwhile, an investor who had the foresight to see that Microsoft (Nasdaq: MSFT) was about to revolutionize the software industry could have picked up the stock at an adjusted price of $0.12 per share. We all know the rest of the story -- MSFT has since soared in value.

The vast majority of investors regret not having bought Wal-Mart or Microsoft 20 years ago, long before they became the behemoths they are today -- but the market seldom gives us a second chance. Or does it?

Consider this: many investors in future years will probably look back at the opportunities available in today's market with a similar sense of regret. Without a doubt, the giants of tomorrow are out there right now -- and there is still time to act.  The secret is knowing where to look.

Many of the blue-chip companies of today were once relatively unknown small-cap companies.  So it makes sense to look towards small-cap companies to find giants of tomorrow.

Small-cap is a term that refers to a company with a market capitalization near the low end of the publicly traded spectrum.  To calculate the market capitalization, take a firm's current share price and multiply that figure by the total number of shares outstanding. In generally, though, the term small-cap is used to describe companies with market values between $300 million and $2 billion.

Of course, finding future leaders is never easy.  This is especially true because of the lack of analysis and financial information available for small-cap companies. This means that most of the burden of researching and uncovering companies with growth opportunities is left to the individual investor.  For this reason, it is more common for small-cap stocks to be inefficiently priced, or not reflective of the underlying firms' intrinsic values.
Because stock prices are a derivative of earnings growth, it stands to reason that a small company with $10 million in earnings can double or triple that figure far quicker and easier than a corporate giant with $10 billion in earnings -- richly rewarding its shareholders in the process.

Long-term performance numbers bear this out:

The small-cap value sector has been one of the single best-performing asset classes, delivering annual gains that surpass those of the S&P 500. 

Of course, the markets are cyclical, and anything can happen over short periods of time. Therefore, long-term performance figures tend to have far more predictive power.

To find out more information on the small-cap segment of the equity market, look to the Russell 2000 Index for an up-to-date list of small-cap companies.