The Golden Rules For Investing In Small-Cap Stocks

Amazon, once sold its shares at $18 per share in 1997. Fast-forward to today, its shares have appreciated by enormous multiples of what it was at its Initial Public Offering.

In February 2020, a single share sold at over $2000. If you don’t immediately understand what this means, this would imply that an individual who invested $10,000 in Amazon in 1997 would be over $12 million dollars rich in 2020. 

I can almost imagine some investors who had an opportunity to but didn’t buy Amazon shares at the time are now biting down on their fingernails in regret. 

But seeing the future isn’t an ability that any of us is gifted with, so there was no sure way to know that a mere online bookseller store would grow to be one of the biggest online stores in the world today.

However, this article isn’t about Amazon. Rather, it is about the small-cap stocks you could buy today that would earn you bountiful rewards in the near future.  

It is about small-cap stocks and the rules for investing in them. Yes, it is about learning to spot the next Amazon or Google. But first, let’s make sure you understand what we’re talking about here. 

What Are Small-Cap Stocks?

Small-cap stocks are stocks that have a market capitalization that ranges from $250 million to $2 billion. When stocks are in this stage, their prices are cheap. 

But what drives people to invest in them is that there is a huge possibility of growth. Any of these stocks could become the next Amazon in the future. Another driver of small-cap investments is that their stocks are often below the radar of institutional investors. 

Amazon was once a small cap when its stocks were cheaper. Now, it has grown to be a vast playground for the big guys: institutional investors.

However, the risk that comes with investing in small caps stocks are enough to make one think twice, or even thrice, before investing in them. 

The ugly reality of many small-cap stocks is that they never make it far from the runway before they crash. Only a very few of them survive long enough to fly. This uncertainty makes them a risky and volatile investment.

But if you knew the golden rules of investing in small-cap stocks, you would position yourself to approach the risk and uncertainty in a better way. 

The Golden Rules of Investing in Small-Cap Stocks

Before we go too far, let’s make sure you are not being deceived. These rules may not lower the stakes of the risks of investing in the stocks so you can just step over it and be a billionaire overnight. However, they do help you learn the best ways to invest

You have probably learned that life isn’t always that easy. Instead, these golden rules will mount some odds in your favor so you have an increased chance at making a satisfactory profit from your investment.

Rule 1: Do Your Due Diligence

This is probably the single most important rule of them all. Digging into the records and history of the company whose stock you want to buy is a way to know in what direction the company is headed. 

This rule might take a lot of your time, but you still have to put in the work. It’s your hard earned money on the line, after all.

Without doing your research, you may not know that the company is neck deep in debts. And except you are specifically looking for a debtor company to invest in, steer clear of such companies. 

That is why you should look into the financial history of the company. Also, do your research to know if the stock has been performing well in the past. Has it been stagnating for some time, or worse, depreciating? 

Usually, this is a marker that this stock is not one you want to dirty your hands in. Don’t forget that small-cap investment is risky. 

Even the stocks that look the most promising sometimes end up crashing, talk less of those that have not had delightful prospects in the past.

Rule 2: Profitable From Sales

This is another thing you need to find out. You want to know if the company whose stock you are investing in has been making profits from the sales of their products. 

Or if they often need cash injection to stay afloat. If the company has been making a profit from their sales, it is always a good sign. A company that makes profit can grow easily. And when the company grows, their stock value increases. 

Rule 3: Cast Your Lots With Experienced Management Teams

When you are doing your research, find out the management team at the helm of affairs of the company you want to invest in. 

Some management teams are novices and may not have been tested in harsh business climates. These are definitely not the people you want to cast your lots with. 

Rather, you want to do business with experienced management teams that have a record of growing small-cap companies. 

These management teams know what problems to expect at every given time in the life cycle of a company. They also know how to either avoid or counter these problems.

Rule 4: Do Stocks That Have Large Markets

Some companies are looking to create new markets while some others are in the service of an already available market. 

According to this rule, ignore the former and embrace the latter. Here’s why: When a company is trying to create a new market, a lot of things could go wrong as there is no way to be certain of the response of people to the product being sold to them. 

Moreover, the market they already have is still a small one, and one that is most likely slowly growing.

When you invest in a large market company, however, you know that the company has many customers. And the more the customers, the more the returns. 

This gives the company enough room for growth and expansion. For example, a company that is about to hit a goldmine in its work towards the development of a vaccine for cancer will have an enormous market to sell its products to. 

On the other hand, a company that already has a vaccine for a virus that may infect people in the future has no guaranteed market. 

Rule 5: Don’t Stick Around For Too Long During Terrible Times

Hey! Small cap investment is not marriage; there is no “for better, for worse” here. When you find out that a company you invested in is taking too long to settle issues that are stagnating its stock, cash out!

Don’t wait and hope that things would get better because they often never do. But in the rare case that the company gets back on track, you can re-invest. But don’t wait for them in bad times.

Rule 6: Never Invest in a Failing Stock

This last rule seems so obvious, doesn’t it? But it would amaze you how many people lose all their investment because they failed to acknowledge this rule. Here’s how they do it. 

When they buy a stock and the value falls to the point where they’ve lost the amount they are willing to risk on the stock, they refuse to sell the stock. Instead, they invest more money in it, hoping that the stock will, one day, soar, and their investments with it. 

Unfortunately, this isn’t always the case in stock investment, especially in small-cap stocks. When the stocks drop, make use of Rule 5. 

The Bottomline 

The risk in investing in small-cap stocks is real, just as much as its rewards. Follow these rules and hopefully, you would bag yourself a lot of profit. 

Read also: 12 of the Best Investment Apps of 2020

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