What are small caps?
Small but plentiful
Small caps are companies with a total stock market value of between 500 million and 3 billion euros. Companies with a stock market capitalisation of between 3 and 7 billion euros are referred to as ‘mid caps’, while those with a market capitalisation above 7 billion euros are referred to as ‘large caps’.
Although the big players such as Apple, Microsoft, Walmart, and so on attract lots of media attention, we should not underestimate their small cousins, the small caps: between 80 and 90% of all stocks in the world are small caps.
Good liquidity management is vital
Large stocks are traded in vast numbers and are more liquid than small stocks, which are sometimes bought and sold in only small numbers each day. Their more limited liquidity can have a bigger impact on the share price, in response to both good and bad news. As a consequence, small companies are regarded as a riskier investment than large, well-known names. Good management and wide diversification are therefore crucial.
Actively seeking out hidden gems
Large institutional players are often unable to invest in small caps because of their more limited liquidity. These companies are therefore tracked by a smaller number of analysts. Those analysts who are skilled at tracking smaller businesses look for hidden gems. The big advantage is that the management of smaller companies is often much more accessible. The corporate culture and financial constructions are usually also simpler to understand. This makes the universe of small caps an ideal reservoir for active management.
Did you know that... ?
… experience and research are the key elements for a successful selection of small caps.
Investing in small caps is an interesting option because of their growth potential. As with everything, a higher potential return comes with strings attached: a higher potential return also means a certain degree of risk.
- Less liquid: Smaller stocks are traded less than shares in larger companies. This means executing orders can take longer, which can be a disadvantage if you want to sell your position quickly.
- More volatile: Lower liquidity automatically means more volatility in the share price. Wide price movements can present an opportunity, but can also be a disadvantage.
- Higher debt ratio: Many small caps have a slightly higher debt ratio, reflecting the extra investments that are needed to fire the business out of the starting blocks. It is a fact that every large stock began small, but it is an illusion to think that every small stock will automatically grow into a large one. There are enormous differences in quality.
In order to strike a good balance between growth potential and risk, it is important to act from a position of knowledge. Active management and stock-picking absolutely make the difference in this field of investment. The trick is to pick out the high-quality smaller stocks and then buy them as cheaply as possible, before they become large and well known.
At KBC you can rely on more than 15 years of experience. Our experts make a very judicious selection from the large pool of small caps. We go for companies which have a strong business model, good pricing power and high profit margins. The profitability on capital employed is our main criterion. Good diversification is essential.