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In this guide, you’ll discover what a small-cap stock is and how it is classified, along with some examples of small-cap stocks that may turn into profitable and established large-cap stocks one day. We also explore other ways of investing in stocks, such as through a stock market index or exchange-traded fund (ETF).
A small-cap stock is a publicly traded company whose total market capitalisation is somewhere between $300m and $2bn, according to Forbes. Anything smaller than this is counted as a micro-cap stock, which tends to include start-up businesses, and anything above is called a mid-cap or large-cap stock.
Investors that are looking for companies in their early stages of growth may decide to add small caps to their portfolio. These stocks usually get less media and analyst coverage, making them a complex but rewarding investment if successful. It also takes a fair bit more research to decipher whether they will make a good investment, but as with all shares in the stock market, nothing is a given.
Small-cap companies can provide benefits to an investor, and here are some reasons why.
Investors may choose to invest in small-cap companies if they expect them to become growth stocks in the future and grow to large-cap status. This way, they’ll get to invest while the company is still growing and witness it turn into an established business, collecting profits on the way. Remember that many blue-chip companies started out as small caps.
Small-cap stocks are an efficient way to diversify your portfolio. Some investors prefer to have a mixture of stocks depending on market cap, sector, and industry.
Historically, small-cap stocks have outperformed large-cap stocks. As you can see in the chart below, before the Dot Com bubble in 2000, the stock market was dominated by large-cap tech stocks (as shown by the S&P 500 index). However, following this crash, small-cap stocks have consistently outperformed its larger peers by a narrow margin over the past two decades (shown by the Russell 2000 index). They perform particularly well during a bull market, but slow down slightly during a bear market when there is economic hardship.
Please note that past performance is not a reliable indicator of future results.
Although small-cap stocks have been shown to outperform their peers in the share market, they also come with their own risks, which are explained in detail below.
Small-cap companies tend to come with a lower level of liquidity, given that there are less investors interested in the market, and a higher level of volatility. This means that it may be more difficult to find willing buyers and sellers for a particular share, which could lead to investors being stuck holding the security for longer than they hoped.
Although small caps come with a greater potential for growth than large caps, there is also a greater chance of failure. These types of companies may not have strong enough financials to support its operations and subsequently face difficulties to keep it afloat.
Small companies tend not to offer dividend payouts to shareholders, as the company is often not yet profitable and can’t afford to dedicate a portion of their cash flow. However, saying this, tech giants like Alphabet and Meta Platforms have never offered a dividend payout, confirming that even companies with some of the highest market caps in the world don’t offer benefits to their shareholders.
Small-cap stocks tend to be more vulnerable to stock market crashes and recessions. For example, throughout the Covid-19 pandemic, small caps fell further than large-cap stocks, which could be due to the fact that there is less stability and investor interest around them to keep their solid status in the market. In fact, investors flocked to safe haven assets such as defensive stocks and blue chip indices, such as the S&P 500, which is emphasised in the chart below.
Please note that past performance is not a reliable indicator of future results.
Below is a list of small-cap stocks that have proved to be some of the best-performing in recent years in terms of steady revenues, returns, dividend payouts, cash flows, and balance sheets.
The following data is taken from Yahoo Finance and is up to date as of December 2021. Please remember that past performance is not a reliable indicator of future results.
| Company | Country | Market cap | Sector |
|---|---|---|---|
| Tullow Oil [TLW] | UK | £614.54m | Energy |
| ReneSola [SOL] | US | $481.26m | Energy |
| Petrofac [PFC] | UK | £577.73m | Energy |
Tullow Oil: British oil and gas company Tullow Oil has over 40 interests in 11 countries worldwide, with a focus on Africa and South America. The business works across all stages of the oil lifecycle, from exploration to production. The company has managed to reduce its debts over the past year, and restraints of oil supply has led to an upward trend in the market, which may possibly continue into 2022.
ReneSola: This small-cap solar stock focuses on power project development, construction management, and project financing services. ReneSola is a pure downstream player operating in regions where solar markets are growing rapidly and becoming profitable, such as the US and Europe. The company may be particularly appealing for those concerned with environmental, social and corporate governance (ESG), which is a major investment trend in 2022.
Petrofac: Petrofac is a British oilfield services provider to the oil and gas industry. The company designs, builds and operates world-class energy facilities that also ensure low emissions. Petrofac works on more than 200 engineering, procurement and construction (EPC) projects worldwide, including the North Sea. It issued £275m worth of new shares in October 2021 that are to be used for ‘refinancing’ in order to create a more sustainable and long-term business model.
| Company | Country | Market cap | Sector |
|---|---|---|---|
| HIVE Blockchain Technologies [HIVE] | Canada | CAD $1.88bn | Information Technology |
| ACM Research [ACMR] | US | $1.71bn | Information Technology |
| DoubleDown Interactive [DDI] | South Korea | $783.15m | Information Technology |
HIVE Blockchain Technologies: This Canadian company is the first publicly traded crypto miner on the Toronto Stock Exchange. HIVE uses green energy to mine both Bitcoin and Ethereum through data centre facilities across Canada, Sweden, and Iceland, also holding a committed ESG strategy. This stock has been on the rise since the rally of cryptocurrencies in 2020 and developments in blockchain technology.
ACM Research: ACM Research develops wet processing technology and products for the semiconductor industry. Its equipment serves a range of applications in integrated circuits (ICs) and wafer level packaging in order to improve the overall manufacturing process, using smarter megasonic technologies. Given the global shortage of semiconductors throughout 2021, ACM Research may be blossoming at the opportune time when demand is higher than ever.
DoubleDown Interactive: South Korea’s leading casual games developer, DoubleDown Interactive, creates multi-format interactive video games for both mobile and desktop players. Its flagship app, DoubleDown Casino, entertains over one million players every day across the world. The company had its IPO in the middle of the Covid-19 pandemic when gaming stocks were experiencing an overwhelming turnover of new customers forced to find entertainment indoors.
| Company | Country | Market cap | Sector |
|---|---|---|---|
| BerGenBio [BGBIO] | Norway | NOK 1.67bn | Healthcare |
| Medigene [MDG1] | Germany | €75.28m | Healthcare |
| Synairgen [SNG] | UK | £406.85m | Healthcare |
BerGenBio: BerGenBio is a Norwegian clinical-stage biotech company. It focuses on developing transformative drugs for aggressive diseases, including advanced and treatment resistive cancers. The company’s main medication, bemcentinib, is an AXL inhibitor currently in the final stages of production. BerGenBio was also involved in drug testing as part of the race to find an oral alternative therapy to combat Covid-19.
Medigene: One of Germany’s rising pharmaceutical stocks, Medigene is working on immunotherapies to treat cancer in fields of high medical need. These include T cell receptor-modified T cells (TCR‑Ts) or dendritic cell (DC) vaccines, the first candidates of which are in the clinical development stage. The biotech company has expanded and merged with several companies in recent years and has a number of FDA-approved products in the US.
Synairgen: University spin-off drug discovery, research and development company Synairgen specialises in respiratory diseases. The company places emphasis on biotechnology for treatments like asthma and chronic obstructive pulmonary disease (COPD). Synairgen shares soared throughout the pandemic as it revealed that its primary drug, SNG001, can be inhaled into the lungs and is successful against the virus in elderly patients.
| Company | Country | Market cap | Sector |
|---|---|---|---|
| Schnitzer Steel [SCHN] | US | $1.28bn | Materials |
| Made.com [MADE] | UK | £537.87m | Consumer Discretionary |
| Qudian [QD] | China | $339.14m | Financials |
Schnitzer Steel: This steel manufacturing and metals recycling company collects, processes, and recycles raw scrap metal. Schnitzer Steel Industries is a global leader, providing both ferrous and nonferrous materials to mills and foundries around the world. It also operates used auto-parts stores in Canada and the US, transforming recycled scrap material into wire rods, coiled bars, and other specialty products.
MADE: Made.com is a British furniture and homeware brand. The company sells high-quality and luxury products online and through its network of seven showrooms across Europe. Since its IPO in June 2021, MADE has attempted to capitalise on the rising interest of home renovation and retailing, which can be attributed to the pandemic. In turn, it saw revenue increases of more than 64% at the start of 2021, which may continue into 2022.
Qudian: China’s answer to fintech, Qudian is an online credit platform which uses artificial intelligence (AI) and machine learning to enhance the online consumer finance experience across the Republic of China. It offers funds in digital form, various types of credit and merchandise credit products, and loan recommendation and referral services to third-party providers.
There is a wide range of small-cap companies that are based in the UK or listed on the London Stock Exchange, including the examples shown above.
The chart below shows the performance of the FTSE 100 stock index, which measures the top 100 large-cap stocks listed on the London Stock Exchange, vs the FTSE 250, which lists companies 101-350 in terms of market capitalisation. As you can see from the image, the FTSE 250 has consistently outperformed its rival index for the past decade, suggesting that small-cap stocks do bring value to the market in the UK, possibly even more so than their blue-chip peers.
Please note that past performance is not a reliable indicator of future results.
When looking for small-cap stocks to add to their portfolio, an investor could follow the below steps:
There are several stock indices around the world measuring companies with a smaller market capitalisation. Indices aim to give an overview or benchmark for a particular stock market sector, size, or industry. We have highlighted four popular small-cap indices among investors.
The Russell 2000 Index is made up of approximately 2,000 US stocks with the smallest market capitalisations. The index contains companies with a median market cap of $1.2bn. This is perhaps the most popular or recognised small-cap index in the US among investors.
The S&P SmallCap 600 Index tracks the performance of 600 small-cap companies listed on US exchanges, as measured by Standard & Poor. The median market cap of each company is $1.4bn.
The FTSE SmallCap Index is a UK-based index that consists of the 351st to the 619th listed companies on the London Stock Exchange (LSE)’s main market. These are also included in the FTSE All-Share Index, which measures every company on the LSE.
The MSCI World Small Cap Index captures small-cap companies across 23 developed markets countries. It has over 4,400 constituents and covers approximately 14% of the free float-adjusted market capitalisation in each country. The index tracks companies with a median market cap of $1.2bn.
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As stock indices cannot be invested in directly, you will need to use an alternative vehicle to gain exposure to small-cap stocks, such as an exchange-traded fund. Small-cap ETFs essentially track indices measuring a portfolio of small-cap stocks, such as those explained above. Here are some of the most popular small-cap ETFs among investors.
| Fund Name | Expense Ratio | 3-Month Total Return |
|---|---|---|
| iShares Russell 2000 ETF [IWM] | 0.19% | 1.51% |
| SPDR S&P 600 Small-Cap ETF [SLY] | 0.15% | 3.24% |
| Vanguard Russell 2000 ETF [VTWO] | 0.10% | 1.75% |
| iShares Core S&P Small-Cap ETF [IJR] | 0.06% | 3.27% |
| Schwab U.S. Small-Cap ETF [SCHA] | 0.04% | 1.05% |
Learn how to invest in ETFs.
FAQs
Whether you invest in small or large-cap stocks depends on a number of things, including what are you looking to achieve and how risk-averse you are. Investors looking for a middle ground could instead choose mid-cap stocks, which offer the growth potential of a small-cap stock but less risks and volatility along the way.
It has been observed that small-cap companies tend to underperform in periods of stock market downturn or recessions. This is why, often, investors flock to safe haven assets such as blue chips and defensive stocks in order to protect their portfolio when the small caps tend to deteriorate.
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