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Small Cap Stocks: All You Need to Know

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Updated March 11, 2024

Some of the best investments started out as small-cap stocks—those with a market capitalization between about $250 million and $2 billion. Of course, not every small-cap company grows into a behemoth like Amazon or Apple (which recently became the world's first company to reach $3 trillion in market cap). Still, investing in small companies can be rewarding, especially because they offer greater upside growth potential than larger companies.

If you're looking for the best stock investments and considering small-cap stocks, here's an explainer to get you started.

Why is market capitalization important?

Market capitalization—or market cap—measures a company's size. It's the total value of a company's outstanding stock shares, including publicly traded shares and restricted shares held by company officers and insiders. To calculate market cap, multiply the company's number of shares outstanding by its current share price. For example, a company with 10 million shares outstanding and trading at $20 will have a market cap of $200 million.

Market cap matters because it provides clues about where a company stands in the business development process. For example, relatively new public companies with smaller market caps may have more room for growth. Market cap also gives a rough indication of a company's stability: Large-cap companies typically are less vulnerable to volatility than mid or small-cap companies.

According to FINRA (the Financial Industry Regulatory Authority), the delineation between market cap sizes varies, but you'll generally see them broken down like this:

Company sizeMarket value
Mega-cap
$200 billion or more
Large-cap
$10 billion to $200 billion
Mid-cap
$2 billion to $10 billion
Small-cap
$250 million to $2 billion
Micro-cap
Less than $250 million

Small-cap stock vs. large-cap stock

With market caps of $10 billion or more, large-cap companies are mature, well-known companies that are key players in their industries. While their days of aggressive growth may be behind them, large-caps typically offer stability, and many pay consistent dividends. Meanwhile, small-caps have historically outperformed their larger counterparts and are more likely to experience rapid revenue and profit growth. However, that potential growth comes at a price: small-cap share prices tend to be more volatile and sensitive to macroeconomic shifts, which can be unsettling to risk-averse investors.

Small-cap stock vs. mid-cap stock

Mid-caps tend to be established companies in industries experiencing (or expected to experience) significant growth. With market caps between $2 billion and $10 billion, mid-caps offer less volatility and risk than small-caps—and greater growth potential than large-caps. For this reason, mid-cap stocks can be a good option for investors looking for a balance: moderate growth potential combined with moderate risk.

Small-cap stock vs. penny stock

Penny stocks have low share prices (under $5) and usually trade over the counter (OTC) via pink sheets instead of on an exchange like most stocks. Because penny stocks have low market caps, they technically fall under the umbrella of small-cap stocks—or micro-caps, to be more specific.

However, penny stocks are far riskier investments because they lack liquidity, have a wide bid-ask spread, and represent a stake in an unprofitable company. Furthermore, some penny stocks are scams, such as pump and dump schemes, where scammers spread false or misleading information to "pump" up prices and then "dump" their shares at an artificially inflated price.

Small-cap stocks and asset allocation

Your risk tolerance and investment goals influence how much cash you should allocate to small-cap stocks versus other types of investments. Here are suggested allocation breakdowns by risk tolerance from the American Association of Individual Investors (AAII):

Investment categoryAggressive investorsModerate investorsConservative investors
Large-cap stocks
20%
20%
20%
Mid-cap stocks
20%
15%
10%
Small-cap stocks
20%
10%
0%
International stocks
20%
15%
10%
Emerging market stocks
10%
0%
0%
Intermediate bonds
10%
30%
40%
Short-term bonds
0%
10%
20%

Advantages and disadvantages of small-cap stocks

Small-cap stocks offer high growth potential, but it's wise to consider the pros and cons before making decisions.

Pros

  • Higher growth potential than mid- to large-cap companies.
  • Lower share prices can make your initial investment easier.
  • Less competition from institutional investors.
  • Variety of companies, from start-ups to established businesses.

Cons

  • Higher risk because they're more sensitive to market changes.
  • Volatile prices can be difficult for some investors to stomach.
  • Less liquidity means they can be difficult to sell quickly at favorable prices.
  • Limited research is available because financial institutions and analysts generally pay more attention to larger companies.

How to invest in small-cap stocks

If you decide investing in small-cap stocks is right for you, you can buy and sell shares of individual companies directly through an online broker, such as TradeStation. If buying individual stocks seems too risky or time-consuming, you can invest in small-cap focused exchange-traded funds (ETFs) and mutual funds, such as iShares Russell 2000 ETF (IWM), Fidelity Small Cap Growth Fund (FCPGX), or Vanguard Small-Cap Value Index ETF (VBR).

Keep in mind that less analyst research is available for small-cap stocks versus their larger counterparts. If you don't have the time, interest, or expertise to make your own trading decisions, consider working with a financial advisor which you can find through services like WiserAdvisor, or a robo-advisor such as M1 Finance.

Small-cap stock indexes

Two main indexes are used as benchmarks for the small-cap equities market:

  • The Russell 2000 Index comprises the 2,000 smallest stocks in the Russell 3000 Index.
  • The S&P SmallCap 600 includes 600 stocks with market caps ranging from $750 million to $4.6 billion, representing 3% of the U.S. market.

Best small-cap stocks based on one-year performance

To find the best small-cap stocks by one-year performance, we used TradeStation's Radar Screen to search the universe of U.S. stocks with market caps between $250 million and $2 billion. We then sorted the results by percent change over 52 weeks to find the top 10:

small cap stocks

A TradeStation Radar Screen showing the top 10 small-cap companies based on one-year performance. Courtesy PowerZone Trading. (Note: TradeStation includes "HB" following a symbol to designate hard-to-borrow stocks for short sale purposes; the extension is not part of the symbol name.)

TIME Stamp: Small-cap stocks have both growth potential and higher risk

Small-cap stocks offer significant growth potential—something large-cap companies can't because their days of aggressive growth are generally behind them. However, the higher the potential reward, the higher the risk. While most investors would love to get in early on the next Amazon or Google, small-cap stocks are riskier than mid- and large-cap stocks because the companies are less established, have shorter track records, and potentially have less access to capital, making share prices more volatile. Small-cap stocks are best suited for investors comfortable with the added risk in exchange for higher potential rewards.

As with any investment, it's essential to do your research before picking individual stocks or funds for your portfolio. If you don't have the time, interest, or expertise to choose investments, consider working with a financial advisor or robo-advisor.

Frequently asked questions (FAQs)

Do small-cap stocks do well in a recession?

According to research from Schroders, small-cap stocks saw a 9.9% annualized net total return during "recession and recovery" periods over a nearly 40-year period that included numerous recessions, including the global downturn of 2007/2008. Large-cap stocks saw average returns of 4.9% over the same period. Of course, remember that past performance doesn't guarantee future results.

Do small-cap stocks do well during high inflation?

According to T. Rowe Price, smaller companies may prove more resilient than many expect during periods of high inflation and rising rates. History shows that U.S. small-cap companies tend to outperform their larger counterparts when inflation and interest rates rise. Furthermore, small-caps have generally led the market recovery following a recession, often outperforming larger companies over multiple years.

Some experts say small caps may do better than large caps during inflationary environments because it's easier for them to pivot and make changes, such as quickly raising prices or finding new sources for goods and materials.

Will small-cap stocks do well in 2023?

For the year-to-date period ending Aug. 18, 2023, the Russell 2000 (which tracks the 2000 smallest companies in the Russell 3000 Index) increased 6.21%. Meanwhile, the Russell 1000—a subset of the Russell 3000 representing the 1000 top U.S. companies by market cap—was up 14.10%. And the Russell Top 50, which includes the 50 largest stocks in the Russell 3000 universe, rose 25.62%.

According to Royce Investment Partners, a small-cap specialist, the year began with an advantage for small-cap stocks, but that edge only lasted until early February. However, it says small-cap performance could see a boost in the coming months as a recession looks less and less likely.

The information presented here is created independently from the TIME editorial staff. To learn more, see our About page.

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