Investing in small-cap stocks is a good way to earn huge returns. The smaller companies often have the most potential for growth. They also carry plenty of risk for investors.
Anytime you buy shares of a small, little-known company, there are a bevy of unknowns. Some small cap stocks are clinical-stage biotechs whose drugs have yet to be approved for commercial use. Others are chipmakers or cloud-computing companies that have plenty of promise but have been simply misunderstood by the market.
It’s impossible to take the risk completely out of small-cap investing. But there are ways to minimize those risks without sacrificing potential profits. For starters, set up a clearly established set of rules ahead of time, and stick to them.
Our small-cap expert, Tyler Laundon, has a very specific set of rules for identifying the right stocks. Those are:
- Search for paradigm shifts in any field of business that requires a unique, new solution that will be provided by a stand-alone company. Then seek a niche supplier that will become an equal benefactor to that pioneering company.
- Invest only when the market opportunity is huge—and quantifiable. Only invest in small companies that serve large, burgeoning markets because you can realize tremendous growth with even small shares of the market.
- Get into a small cap stock before institutional investors become aware of it. Sometimes it takes a while for the big hedge funds or mutual funds to discover small yet promising companies. Once they do, it quickly drives up the price.
- Invest in small caps that offer both growth and value. Look for relatively young companies with growing sales, yet is undervalued based on the company’s market potential versus its total market capitalization. A balance sheet with little to no debt is also a big plus.
- Invest at the right time in the product cycle. There is a direct correlation between the time of investment and the degree of risk and rate of return you can expect. The time period after venture capital investors come aboard is generally the most promising.
- Lastly, concentrate on the very best ideas. Look for industries that have hit a roadblock and need new technologies to keep growing. The small companies that provide those breakthrough technologies make for the best small cap stocks.
These rules won’t help you pick all winners. But they should give you a leg up in selecting the right small caps.
They have certainly worked for Tyler in his years as a small-cap analyst. Between 2012 and September 2015 his small-cap recommendations generated cumulative returns of more than 2,300%, including both winners and losers, and outperformed the Russell 2000 Index by an average of 28% per year.
Tyler applies those winning philosophies as editor of our Cabot Small-Cap Confidential advisory. Searching for small cap stocks can seem a bit overwhelming. In the Cabot Small-Cap Confidential advisory, Tyler does all the heavy lifting for you, identifying those hard-to-find small caps that can earn you the kind of triple-digit returns that can transform your portfolio.