Investing in small-cap stocks

What are small-cap stocks?

Small-cap stocks are shares of companies with a relatively small market capitalisation. Typically, these small-cap companies have market caps between $300 million and $2 billion. They’re often in an early growth business stage, and as such are seen as higher risk investments than more established, large-cap companies.

Small-cap stocks definition

Small-cap stocks represent publicly traded companies with relatively small market capitalisations compared to other public companies in the market. They are often seen as high-risk with the potential for large stock price gains, as they are not yet established in the marketplace but offer significant growth potential.

Small-cap stocks categorisation criteria

Small-cap stocks are categorised based on their market capitalisation. Investors and analysts use these classifications to determine a company’s size relative to others in the market. As a general estimate, market-cap ranges for categorising stocks are as follows:

• Small-cap stocks: Companies with market caps of $250 million to $2 billion
• Mid-cap stocks: Companies with market caps between $2 billion and $10 billion
• Large-cap stocks: Companies with market caps above $10 billion

Small-cap stocks are quantitatively categorised as growth or value companies, expected to either grow earnings or sit undervalued based on fundamental analysis.

Examples of small-cap stocks

Examples of small-cap stocks include companies in emerging industries such as artificial intelligence, biotechnology, cloud computing, and renewable energy. The best small-cap stocks with huge growth potential are well-positioned in emerging industries and stand out from competitors either through exemplary management, a unique business model, or strong funding sources.

Some examples of promising small-cap stocks to buy are:

• Small-cap AI stocks: Innodata Inc (NASDAQ:INOD) is a data engineering company providing AI software to facilitate the use of large amounts of unstructured data, specifically for clients in the insurance and healthcare sectors. Innodata's stock is trading +77% YTD after a strong Q4 earnings report.*
• Small-cap biotech stocks: Bright Minds Biosciences (NASDAQ:DRUG) develops novel treatments for depression, epilepsy, and post-traumatic stress disorder. The company’s market cap sits just within the small-cap range at $256 million with shares trading –11% YTD.*
• Small-cap tech stocks: Himax Technologies (NASDAQ:HIMX) is a semiconductor manufacturer based in Taiwan. The company has a market cap of $1.8 billion with its stock price up 3.23% YTD.*

*as of February 21, 2025

How are small-cap stocks categorised by market capitalisation?

Small-cap stocks are categorised by market capitalisation. The market capitalisation range for small-cap stocks stretches from about $250 million to $2 billion.

Mid-cap vs large-cap stocks comparison

Small-cap vs. large-cap stocks

Key differences between small-cap and large-cap stocks

• Growth potential: Small-cap stocks generally offer higher growth potential compared to large-cap stocks.
• Volatility: Small-cap stocks are generally more volatile than their larger counterparts due to limited liquidity and lower institutional investment
• Risk factors: Small-cap stocks hold greater exposure to economic downturns and business failures
• Return on equity: Small-cap stocks have historically offered higher returns than their larger counterparts because of the low initial buy-in cost. Of course, that return only comes if the company succeeds later on.

Small-cap stocks growth potential, volatility, and risk

Small-cap stocks provide opportunities for higher returns but also come with greater risk. Higher-risk investments including small-cap stocks should make up a lower percentage of your portfolio than those with safer returns; personal research into a small-cap company’s business model and operations may be necessary as there is often less publicly-available professional analysis of these stocks.

Small-cap stocks vs. mid-cap and large-cap stocks

By comparison, mid-cap stocks may still hold some of the prized characteristics of small-cap stocks: a greater potential for high returns and growth value. Yet, these companies have also somewhat proven their ability to expand business operations and grow their value already. A larger market cap comes with greater scrutiny as well, so investors have more information on these mid-cap stocks with which to base investment decisions.

Advantages and disadvantages of small-cap stocks

Advantages

• Higher growth potential: Many small-cap stocks experience rapid expansion
• Access to innovation: These stocks often belong to emerging industries like AI and biotech, which hold an expectation to provide ample room for growth, whether it’s by government subsidies or increased excitement from private investors
• Undervalued opportunities: Some small-cap companies may be undervalued due to limited analyst coverage
• Diversification benefits: Exposure to different sectors and industries
• Historical outperformance: Small-cap stocks tend to outperform large-cap stocks during economic recovery periods

Disadvantages

• Higher volatility: Greater price fluctuations compared to large-cap stocks
• Limited liquidity: Lower trading volumes can result in price inefficiencies
• Less access to capital: Smaller firms may struggle to secure financing
• Limited analyst coverage: A small amount of information on these companies may make personal research difficult
• Greater risk of failure: Young companies face higher business risks

*past performance is not indicative of future results

How to invest in small-cap stocks

Investing in small-cap stocks requires strategic planning and thorough research. Investors should conduct their own fundamental analysis, evaluating company financials, management quality, and overall industry trends. A proper risk management strategy should also be implemented, including diversification wherein small-cap stocks make up a small portion of your portfolio.

Investment vehicles like a small-cap stocks ETF can help avoid overexposure to a single stock or sector while allowing you to invest in several small-cap stocks. Specific small-cap stock indexes like the Russell 2000 and S&P 600 can be useful to track market performance for small-cap stocks in general.

Small-cap stock indices

Russell 2000 Index (US)

The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The largest industries are industrials (19.4%), financials (18%), and healthcare (16.7%). The index has an annualised 5YR return of 8.67%.

S&P SmallCap 600 Index (US)

The S&P SmallCap 600 Index tracks 600 small-cap companies based on financial viability and liquidity. The most-represented sectors are financials (17.9%) industrials (17.5%), information technology (14%), and consumer discretionary (14%). The index has an annualised 6.77% 5YR return.

FTSE SmallCap Index (UK)

The FTSE SmallCap Index covers UK-based small-cap companies outside the FTSE 250 listed on the London Stock Exchange.

MSCI World Small Cap Index (Global)

The MSCI World Small Cap Index includes small-cap stocks from 23 developed markets countries worldwide.

STOXX Europe Small 200 Index (Europe)

The STOXX Europe Small 200 Index tracks 200 small-cap stocks across European markets.

Conclusion: The role of small-cap stocks in your portfolio

Small-cap stocks can play a crucial role in a well-diversified portfolio. Their high growth potential and ability to outperform during market recoveries make them attractive for investors willing to take on additional risk. However, due diligence, diversification, and thorough risk assessment are critical when considering these high-risk assets.

Disclaimer: FOREX.com Australia is a Contracts for Difference (CFD) issuer and our products are traded off exchange. We do not offer direct ownership of the product and exposure to small-cap stocks is available solely via Contracts for Difference (CFDs). This material relates to the underlying asset and does not constitute a recommendation or offer to trade.