Investing in small caps can be more profitable than large caps, especially if you have a large risk taking capacity
Stock market investors must have sufficient knowledge to determine which stocks are the right choice for their investment strategy. The share market has inherent risks, which vary from one stock to another. Every investor at some point gets stuck with questions about which stocks to invest in, be it a beginner or a seasoned investor. Stocks are classified based on the market capitalisation.
Before going into which kind can benefit you more, let’s find out what each of these mean. Stocks are generally classified into three types:
Large Cap Stocks
Large-cap companies are businesses that are well-established and have a significant market share. Large-cap companies have market caps of Rs 20,000 crore or more. Large-cap companies have strong market presence and their stocks are generally considered to be very safe because of lower risk. Most of these companies regularly disclose information through media, such as newspapers. In other words, information on large-cap companies is very readily available.
Mid Cap Stocks
As the name itself suggests, mid cap companies fall between large and small cap companies. Companies that have a market capitalisation of more than Rs 5 crore but less than Rs 20 crore come under this category. Since they're in the middle of their growth curve, these companies are expected to grow and increase in profits, market share, and productivity.
Small Cap Stocks
Small-cap companies are those that have a market capitalisation of less than Rs 5 crore. Small-cap stocks lie at the other end of the market capitalisation spectrum. Most small-cap companies are either start-up enterprises or companies in the development stage. Understandably, they have low revenues and a small number of employees and clients. Information on these companies isn’t easily available to all.
What’s better?
The meaning of large cap and small cap are generally understood by their names which indicate how valuable they are in terms of market capitalisation. Labels like these can often be misleading because many people run under the assumption that they can only make money by investing in large-cap stocks. If you don't realise how big small-cap stocks have become, you'll miss some good investment opportunities.
Investing in small-cap companies should be an important element of your investment strategy. Smaller companies tend to have a greater chance of large growth, faster. For instance, a small- or mid- sized company has a higher scope of growth than already developed company. This is exactly what makes small-cap stocks a big winner for investors with a long term investment plan and risk appetite.
Not all small caps are investment worthy, but some small caps which were overlooked by the market, in spite of being quality companies, turned out to be capital compounders.
Even though large caps are considered safer bets, and have indeed given good returns, small caps might still make better bets, provided they are purchased at a time when the market is not in favor of most small caps. That is when the valuations are bound to be depressed, as you could make good money in this scenario.
Small and mid-cap stocks have shown an exponential growth over the years. To name a few, Graphite moved from 100-odd levels to 700 in less than a year, or, in 2020, Tanla Solutions, which took a jump from being valued at Rs 30 to Rs 900, are great examples. Even though it’s quite underestimated, having a 20-25 per cent of your portfolio in these multi bagger small and midcaps can enhance your returns overall.
If you’re a younger investor, you have the ability to take on more risk. This is because the timeline before retirement is much further out for you than somebody who is closer to retirement age. The investment has the capacity to show tremendous growth and may reach higher when compared to large caps, which are already at the peak. Remember, rewards don’t come without risks in investment.
The author is Co-founder, Catalyst Wealth
DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.