Buying Small-Cap Growth Stocks: Your Six Point Checklist
Including some small capitalization, more speculative growth stocks in your portfolio should always be part of your long-term investment plan. Small-cap companies require a little more research in order to find suitable companies to invest in, but the long-term benefits can far outweigh any added risks in terms of investing in more speculative and "risky" companies. Here is my six point checklist for investing in suitable small-cap growth companies:
1) Allocate a small portion of your portfolio for "small-cap" stocks. Small-cap companies can provide you some great opportunity for gains, however there is also added risk involved as well. These companies can carry more risk as they are unproven. There is nothing wrong with investing in small-cap growth stocks, however make sure that you are not invested too heavily in them. Small-cap stocks require patience; if you invest too much of your portfolio in them, you are bound to have sleepless nights as they fluctuate up and down.
2) Don't invest in "broken" companies. By this I mean, don't invest in a company that used to trade at $17 and now trades at $3, unless you have a very good reason. The problem with investing in these situations is that there is a ton of "overhang" in the stock. This means that many people are stuck in the stock at higher prices, and it will be hard for the stock to ever gain any real momentum because there will always be waves of selling every time the stock moves higher. I prefer situations where the stock is currently trading at $1.75 and the all-time high is $2.50 or something. That is a stock that can move much higher than a stock that used to trade at $17. Don't fall into the trap of "it used to trade at $17, it can easily trade that high again", because they rarely do.
3) Understand the product or service that the company is offering. Do your research. Know the companies product inside and out. What do they produce? Who do they sell to? Who are their customers? Who are their potential customers? Who are their competitors? Does anyone else have a better product? What is their market share? What is their potential market share? These are all questions that you need to find the answers to.
4) Research the management of the company. Which previous companies have they worked for? Where did they go to school? Are they heavily invested themselves in the company? Are they actively purchasing shares, or are they actively selling? You want management that has a large personal financial stake in the company - that's always a good thing. If they believe in the company, they will be buying shares. Also, Google some of the leading management names in the company. Do they turn up in any SEC filings at all? Have they ever been punished for breaking securities laws? Find this out.
5) Research the share structure of the company. I prefer to invest in companies that have a small float, as this can lead to greater gains when the stock starts to take off. When the stock does rise, the company will likely dilute the float by doing secondary offerings or selling shares.
6) Contact the company. If you have some questions, contact the company. If you don't have any questions, make some up. Tell them that you have some questions about the company that you would like answered before you are going to invest. If the company contacts me back in a suitable period of time, that is a big plus for me. If they ignore me, then I am moving on to the next company.
If you follow this six point checklist, you will give yourself a much better chance of finding high quality small-growth cap stocks that could pay off substantially for you in the future. Just like with anything else, there are rotten apples and there are gems.
Filed under: Stock Market Education | General Knowledge