When you start investing, you hear a lot of people talk about diversification. Most people understand that it’s essential, but may not know how to pursue it. One of the best ways to start diversifying your investments is by buying small-cap stocks.
These stocks have a market cap of less than $2 billion, hence the term “small-cap” And “Emerging Growth.” Since they’re smaller, their value is more volatile, which causes many investors to hesitate. Despite this risk, and to an extent, because of it, small caps can be an excellent choice for diversification.
Diversifying your investments means more than just investing in different sectors. It also means spreading money across various asset classes, and small-cap stocks are a critical class to include.
Small-cap, and Emerging Growth stocks’ volatility can dissuade potential investors, but it also means a chance of higher returns. They are typically newer companies, so they give you ground-floor access to something with considerable growth potential. Some small caps in the past have started at less than $2 a share before skyrocketing to $50-plus a share.
Of course, not every small-cap stock will see explosive growth, and many are more likely to fail. Historically, though, small caps have tended to perform better than stocks in larger corporations. On average, small-cap stocks outperform large-caps by 6% year-over-year when there’s a wide valuation gap between the two.
The chances of finding the next Apple are rare, but small caps can still offer substantial returns. Their potential for considerable growth makes them a must-have in any investment portfolio.
Diversification Offers Security
The word “risk” can be intimidating, so hearing that small-cap stocks are typically higher-risk may be discouraging. Remember, though, that ROI is the reward for risk, so you don’t want a risk-free portfolio. Diversifying your investments also ensures that taking risks in some areas won’t affect you as much.
Different asset classes all have varying characteristics that make them more or less risky. While small caps are generally more volatile, the dollar’s value doesn’t affect them as much as large-cap stocks. Small-cap companies don’t often deal in international trade, so a stronger or weaker dollar doesn’t substantially change their value.
Since different conditions favor various asset classes, diversification provides financial security. Typically, periods where large-cap stock values declined see growth for small caps and vice versa. If you don’t have any small-cap investments, your portfolio could suffer when large-cap companies encounter issues.
Small-Cap Investing Opportunities
While most small caps trail the S&P 500 right now, it may be a good time to invest in these stocks. As previously mentioned, large valuation gaps have historically preceded impressive growth for small-cap stocks. With that in mind, here are some small-cap opportunities to consider.
Right now, the small cap with the lowest 12-month price-to-earnings ratio is Unisys Corp. (NYSE: UIS), an IT consulting company. Not far behind Unisys is XBiotech Inc., (NASDAQ: XBIT) a biopharmaceutical company, and VirnetX Holding Corp., (NYSE: VHC) which deals in communications software. These stocks offer some of the highest profits per price for small caps today.
The pandemic has created some unique small-cap, and Emerging Growth investing opportunities. For example, Axos Financial (NYSE: AX) is a financial services small cap, and since it’s all-online, it could have an advantage during COVID-19. Similarly, Yext, (NYSE: YEXT) a small cap that helps companies keep their online info up-to-date, is becoming more valuable thanks to the pandemic.
You could also consider investing in the Russell 2000 index, an exchange-traded fund of the leading 2,000 small-cap stocks. If you’re not confident in your ability to choose a promising small cap on your own, this may be preferable.
Improve Your Portfolio with Small Caps
Diversifying your investments is critical to creating a strong investment portfolio. Investing in small-cap stocks may seem intimidating, but it can be a profitable venture. No portfolio is complete without diversity, and small caps are an excellent way to add that diversity.
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