SUMMARY

1. Introduction and definition

2. Advantage of small cap stocks

3. Difference between small and big cap stocks

4. Out of focus with Wall Street

5. Index to study future price of small cap stocks

INTRODUCTION AND DEFINITION: The term small cap stock is used extensively in the stock trading jargon nowadays. But there are many people who do not understand the actual meaning of the term. The following article is an effort to familiarize the reader with small cap stock and other terms associated with it. It is by far sensible to enter a new and unknown territory, well informed.

The term cap means market capitaliza0tion and is simply calculated by multiplying the price per share by the number of outstanding shares. Cap or market capitalization is an indicator of the stock markets estimate of the value of a company.

small cap stocks refer to the stocks which have a comparatively small market capitalization. The definition of small cap differs among brokerages, but generally in the US a company with a market capitalization of between $300 million to $2 billion is considered as a small company. Classifications such as large cap or small cap are only approximations and are likely to change over a period of time.

DIFFERENCE BETWEEN SMALL CAP AND BIG CAP STOCKS: The meanings and also the differences between small cap and big cap stocks are generally understood by their names. small cap stocks are shares of smaller companies. While big cap stocks refer to the shares of largest publicly traded companies like General Electric or IBM. Big cap stocks are also known as blue chip stocks. Labels such as these can not only be far from actual facts, but such definitions can also change over a period of time. What was small cap stock some ten years back, might be big cap at present. The reverse is also equally true.

Big cap stocks are generally believed to carry lesser risk than small cap stocks. But as evidenced by Enron, this is a poor assumption. It may be noted however, that fall of the big cap the stocks hit the stock holders harder.

ADVANTAGE OF SMALL CAP STOCKS: The greatest advantage of small cap stocks is the opportunity it affords to beat institutional investors such as mutual funds. As mutual funds have certain restrictions that prevent them from buying large portions of any one issuing companys outstanding shares, some mutual funds would not be able to give a meaningful position in the fund. In order to overcome these limitations, the fund would usually have to file with the Securities and Exchange Commission (SEC). That would ultimately lead to inflating the hitherto attractive price.

Due to their low valuations and the potential to turn into big cap stocks over time, small cap stocks are excellent investment opportunities to investors who can not invest in a big way.

OUT OF FOCUS WITH WALL STREET: The companies in the small cap stock sector are being systematically dropped from their coverage list by Wall Street, which is focused on a small number of big cap stocks because most of the money is generated there.

However, it is still worthwhile to take a look at the small cap stock companies even though they are not covered by Wall Street. The reason is their value. It is true that there are some companies in this category that do not merit any attention whatsoever. It is equally true that there are many small cap stock companies that do not get the value they deserve because investors are unaware of them due to their not receiving any research coverage by Wall Street. These companies however, have solid fundamentals and should merit a look by investors.

INDEX TO STUDY FUTURE PRICE OF SMALL CAP STOCK: It is important to carefully observe the movements of a broad based index of small cap stock companies before investing in them. Such an index should ideally be composed of companies which resemble those of the securities found in the investors portfolio.

There are two very popular indices in the US are that are used by stock traders to gauge the direction of any small cap stock. These are Standard and Poors 600 and Russell 2000. Standard and Poors 600 is composed of six hundred small cap stocks. It is generally less volatile than other small cap stock indices because small cap companies must meet strict standards in order to be included in the Standard and Poors 600 index.

Russell 2000 on the other hand is a far more comprehensive index of the small cap segment in the US markets. It is composed of the two thousand smallest cap companies. Many traders prefer to use the Russell 2000 index over the Standard and Poor 600, because the former observes the movement in a far larger number of small cap stock companies than the latter, and thereby provide a much more accurate depiction of the future direction of the small cap stocks.

If an investor follows either of these indices, he should have a good grasp of the general trend of the majority of the US small cap stocks. It will definitely be harder to profit from a small cap stock when the general trend of either of the aforesaid indices is down.