Companies with low market capitalization are often referred to as smaller quoted companies (SQCs) and the stocks from these companies are called small cap stocks.
There are some problems related to investing in small cap stocks which are explained below to make things clear for investors as well as traders.
If the company is still in its budding phase, there are equal possibilities of success and failure. Also, an emerging company might take a long time to reach mid-cap or large cap level that turns undersized investors to millionaires; and if the company has already outshined in the past and is now fading away due to drop in demand, stagnation in business strategies and outdated business plan, the company might not regain market capitalization and keep dropping down, making new lows ever till it disappears. In all the above mentioned conditions, investors either end up shifting their portfolio completely to a different sector or company or might shrink their investment amount.
Small cap companies face tough competition by large caps in the same sector. In the business war between small cap and large cap, chances of winning for large cap companies often remain more. On this, small cap stocks commonly face heavy setbacks. Lots of small companies are time and again swallowed larger competitors, and many are forced to shut down their business entirely. Investing in small cap stocks might turn out to be a nightmare under such conditions.
Often, one can spot large cap stocks on the business news channels and investment websites stuffed with articles on multi-baggers and large cap stocks, undervaluing other stocks. Small cap stocks aren’t much talked about and this also makes it difficult to track their performance, check out their histories, charts, graphs, business numbers and future price evaluations. While the investment world focuses on the large cap stocks, small cap stocks often receive step-mom treatment, making them even less important.
Small cap stocks are seldom seen offering dividends to the investors as they emphasize on company expansion possible with all extra earnings. For those who think of stock investment as a steady source of income need to invest elsewhere.
Because small cap stocks are often driven by market momentum or are pulled up by their sectoral peers, they do not cling to a steady growth and upward movement independently. They might get the growth spur for the moment but do not commit profits. Unlike steadily rising large cap stocks, small cap stocks are more volatile, unstable and fluctuating.
When the overall market sentiment is positive, all the stocks are seen in green, but small cap stocks can anytime drop down with negative sentiments and rumors in the stock markets. Because they do not yet have long-built reputation and faith among the investors, their shareholders are quite likely to shift their portfolio to some other, safer stocks at the time of crisis, when the small cap companies actually need them the most.
As small cap companies usually work on thin volumes, the chances of diminishing of a company are always larger in comparison to a larger cap company.
However, it has been often observed that profits lie just beneath the risk. For investors with high risk appetite, small cap stocks many times turn out to be an opportunity to grow their investment portfolio multiple times but it can be horrendous to other investors.
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