If you want your money to grow legally yet exponentially then the stock market is the most ideal investment option for you. In this industry, you can find multiple financial instruments through which you can trade and gain higher returns. Most of the financial experts always recommend investing for a fairly long amount of time if you want to generate handsome revenues.
As an investor, it is important for people to invest in better quality stocks as well as other investment vehicles in order to build a proper and well-diversified investment portfolio. While diversifying your investments make sure that you have also included small cap stocks in your portfolio. In this article, we will discuss all the information you will require before investing in small cap stocks and what are the best small cap investment stocks you can choose from in 2022.
Key Takeaways
- Small cap companies can offer a handsome return on investment if you are patient enough.
- You will have to analyze the company very carefully before investing in small cap stocks.
- There are various risk factors associated with small cap stock investment therefore you will have to strategically invest in them.
- For investors outside India, there are various fees associated while investing in small cap equities.
- If you want to gain maximum returns from small cap stocks then you will have to invest your money for a very long time.
- The management of the company is a determining factor when choosing the small cap company to invest in.
Summary in brief
- Definition of small cap stocks
- Where you can avail of small cap stocks in India
- Things you need to know before investing in small cap stocks
- Risk factors involving small cap stocks
- Frequently asked questions
What is Small Cap Equity or Stocks?
In the stock market, the companies that come under the 2 billion market capitalization are considered small cap companies.I. The differentiating factor for small cap companies in the stock market is that their overall market capitalization is below Rs. 5000 Cr.
This is a particular type of stock market classification which is dynamic and changes according to the market valuation of the company. The term market valuation refers to the company’s remaining amount of share available in the market.
According to the Securities and Exchange Board of India or SEBI, the companies with the rank of 251 and beyond in terms of market capitalisation would be termed as small cap. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) both have the small cap benchmark index to track the overall performance of the small cap shares in India. The name of this index are BSE small cap Index and Nifty Small cap Index.
More About small cap Companies in India
As an investor, you should know that every large cap and midcap company was once a small cap company. Once these companies started to sustain their businesses and increase their revenues step by step, they became midcap and large cap organisation.
Although these companies have higher growth potential, they also have a very risky approach. Usually, high risk tolerant and aggressive investors put their money into best small cap shares with the idea of generating higher revenues.
Points You Need to Keep in Mind When You are Investing in a Small Cap Company Stocks
Financial power
Financial strength of any company is one of the most common criteria for every investor before thinking about investing their money into a company. In general, the financial strength of a small cap company cannot be compared with a mid cap or a large cap company because the small cap companies cannot match the sales or subscription figure.
Nevertheless, if the companies have a standard cash flow, proper balance sheet, and a minor amount of debt then these small companies will be able to survive the market and do better than the rest of their competitors.
Therefore, if you are thinking about making an investment then the size of the company may not necessarily matter but it is definitely important to look after the financial growth and stability of the small cap companies in India before choosing to invest in them.
Past performance and growth
Before investing in a small cap company in India, it is important to check the past performance of the companies you are investing into. These companies should possess a satisfactory performance record of at least five years. For example, you can look into the company’s sales record, profit, CAGR growth record, etc.
If you compare the performance of a small cap company with other companies of the same category, you will be able to find out how well it has performed in the past few years. If a company consistently performs well in the market in comparison to its peers, investors will eventually receive higher returns from the same. As an investor, you should perform your own research and analyze the stocks very carefully before making your investment choice.
Overall size and position of the company in the stock market
Normally, the small cap companies focus on providing a single service or product to their customers. That is why it is important to have knowledge of the entire business market size and the company which is operating it. It is also equally important to know the whereabouts of the company in that specific market.
This entire information will help you gain a broader outlook on the overall position of the company in the current market scenario. Things like entry barriers, niche positioning, etc. can have a significant impact on the overall valuation of the small cap stocks India.
Company’s management quality
In order to determine the company’s future growth, every company’s management has a pivotal role. If you are thinking about investing in a small cap company then as an investor, it is important for you to evaluate the current management of the company as well as its history.
Due to inflation in the financial statement and poor governance of the company, a lot of small cap companies went bankrupt. If a company is facing a legal battle, then try to avoid dealing with those companies. In most cases, the small cap stocks get saturated due to regulatory or legal challenges and that is why it is better to avoid these types of companies.
Risks Associated with Investing in Small Cap Companies
If you are interested in investing in small cap company stocks in India then you also need to be aware of the risks associated with the investment. Here is the potential risk you may have to face while making an investment in small cap companies:
Market Volatility
The stock market is always volatile and therefore the stock prices can change over time. In comparison to large cap or mid cap stocks, the small cap stocks are more dynamic. There is not much cash flow when it comes to small cap equities and they are also less established.
This volatility can make the prices of stock increase and decrease rapidly. If the investor is searching for a steady income stream then it is difficult to achieve the same through small cap stocks.
Time period of investment
Generally, if you are patient enough you will be easily able to generate returns through investing in small cap companies but this is only applicable if you wait for a long time between the selloff and purchase of the equities. If you are looking for quick cash then investing in a small cap company is not the perfect idea.
Additional risk factors
Normally, the small cap stocks are considered high risk investments because they are mostly not well known among other investors which is the exact opposite of large cap and mid cap companies. Due to the same reason, the equity prices of the small cap companies can change drastically.
Investment returns
The small cap stocks have the ability to provide you with higher returns than the large cap equities. Nevertheless, you also need to note that the returns you will receive after investing in small cap companies are not consistent at all. Sometimes they may provide you with higher returns simultaneously; they can also underperform within a specific tenure.
Investment cost
In comparison to the investment cost in large cap and mid cap companies, the overall value of investing in a small cap is significantly less. Yet, as an investor, you will also have to pay other fees such as transaction costs, brokerage fees, etc. Therefore, before making an investment think and make your decision accordingly.
Taxation
If you are not a resident of India then you may have to buy shares of a small cap company through an Indian broker but you will have to pay capital gain taxes under the Indian tax laws. That is why you also have to consider if investing in equities will incur profit or loss for you while dealing with small cap stocks.
Growth of the company
Another way you can evaluate a company as an investor is by looking at how much revenue it generates every year and the amount of money it has in hand. This is how you will be able to find out if the company is financially stable or not. If the small cap company does not have enough money at its disposal, then it is highly likely that it won’t be able to reimburse its own employees and other company-associated bills.
List of small cap Companies You Can Invest in 2022
| Name | Subsector | 5 Year Revenue growth (in %) | 5 Year Returns in (%) |
| Nureca Ltd | Pharmaceuticals | 566.60% | 46.4% |
| Xtglobal Infotech Ltd | Software Services | 491.66% | 3,454% |
| Gautam Gems Ltd | Precious Metals, Jewelry and Watches | 437.95% | -50.3% |
| Rattanindia Enterprises Ltd | Power Trading & Consultancy | 385.43% | 641.6% |
| Sobhaygya Mercantile Ltd | Diversified Financials | 347.30% | 211.6% |
| Stratmont Industries Ltd | NA | 344.36% | 129.4% |
| Balu Forge Industries Ltd | Industrial Machinery | 330.17% | 50.6% |
| Flomic Global Logistics Ltd | Diversified Financials | 295.30% | 28,800% |
| Palco Metals Ltd | NA | 276.43% | 22.2% |
(Price date as per June 22, 2022)
FAQs
Is it worth investing in small caps?
Mostly the small cap value index outperforms the S&P 500 in the long run and the separate small cap stocks provide a higher potential for growth. The small cap shares also face higher volatility and the associated risk factor is also very high.
Why is a small-cap fund risky?
In comparison to the large cap companies, small cap companies are riskier investments. Although they don’t have the capacity or resources of a large cap company (which makes them fairly vulnerable), the small cap stocks have the potential to offer better returns on investment.
Are small cap stocks good for long-term investments?
Due to its tremendous growth potential, it is better to offer a long investment window while dealing with small cap shares. It is recommended to invest in a good small cap share for at least eight to ten years in total.
Do small caps have the ability to outperform the large caps?
The small caps have always historically surpassed the large caps but you need to invest in this asset class with utmost caution. As an investor, you also need to have a higher risk tolerance so that you can support yourself in case you suffer losses. While small caps provide higher investment benefits it is also fairly risky.
What is the average return on small-cap stocks?
The average return on small cap stocks is 27.9 after a ten-year-long tenure.
