Small-Cap Stocks – Not always Small Opportunity

Though the definition of Small-Cap Stocks may vary between brokerages, they generally refer to stocks with a relatively small market capitalization of between $300 million and $2 billion. For investors there are always hidden gems in the small-cap stock market. However, sound advice from a financial advisor and due diligence is more valuable than self-proclaimed gurus selling you their latest stock market gimmicks, online companies with their guaranteed technical systems, new age economists with their complicated economic models, or broker-dealers and their colorful graphs that all promise you “instant millionaire” status. After receiving a stock alert, there are numerous ways of checking on the potential investment you are considering.  Keep in mind also that a lot depends on the present state of our economy, the company’s position in the market place, its product line, and the strength of the business—including the executive leadership and the company’s profits.  There are also online companies like Reuters that offer a wealth of information on small-cap stocks. Another factor of significant importance is the company’s earnings-per-share ratio, or the P/E ratio.  This helps determine whether the stock is overvalued or not.  At Reuters you can compare the P/E ratio of a company to the average P/E ratio of companies in its industry.  A good rule of thumb when evaluating small-cap stocks is to stick with companies with lower P/E ratios. Ask for a financial report of the company before you buy.  It is important to check the cash flow statement to evaluate how the company has spent its money.  A healthy maker is the cash flow from its operating activities or what the company took in for its primary business activities. That number should be positive or have had a positive trend during the year to make it a viable and lucrative investment. Also check insider activity.  If any executive staff members sell large quantities of stock, that is not a good sign and can be an indication of the company’s present financial woes; however large increases in purchases would be a better indicator of a good small-cap stock. The debt of a company is not always a negative indicator as long as historically it has not been rising rapidly and it is used to grow sales and earnings.  The debt/equity ratio is another good indicator of a healthy company.  Compare this ratio with competitor companies to check viability and whether it is within reasonable limits.    

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