Investing in small-cap stocks can create a wide range of challenges for investors. However, many companies with a small market cap eventually turn into large companies with massive valuations. Some notable examples include Amazon, Inc. (NASDAQ: AMZN) and Netflix, Inc. (NASDAQ: NFLX).
In 2004, shares of NFLX were worth just $2 while the company’s total valuation stood at $1 billion. In 1999, shares of AMZN were worth just $5 while the company’s total valuation stood at $1.5 billion. Both of these companies have taken-off into the stratosphere in the periods that have followed and the investors that were able to see the expansive vision of these companies were able to amass fortunes in the process.
Of course, not all small-cap stocks are able to claim the successes of an AMZN or NLFX. Investment in small-cap stocks often carries a substantial amount of risk, and it’s generally not advisable for new investors to initiate sizable exposure to these assets classes. Generally speaking, newer investors looking to get into the world of small-cap stock trading will instead focus on a benchmark like the Russell 2000 Index because of its broader diversification advantages and limited exposure to single-stock instruments.
An assessment of the Russell 2000 can also be a good way to gauge the state of the small-cap market as a whole. In cases where the benchmark is falling, investors can see that there are enhanced risks involved and that it might be preferable to buy safe-haven assets. Alternatively, times of strong economic stability tend to see small-cap stocks rally sharply because investors are willing to take on the perception of greater risk with the hope of gaining rewards that outperform the rest of the market.
The central comparisons here are usually drawn in relation to the S&P 500, which is the most closely watched large-cap stock index in the world. Enhanced volatility in equities was largely prevalent during the summer trading period and that this had a disproportionate effect on the small-cap space. The Russell 2000 benchmark index is currently trading -14.35% below its record highs (which were posted in August of 2018) and this is far below the performances seen in the S&P 500 on a year-to-date basis.
That said, some of the best small-cap stock performers in the Russell 2000 have actually surpassed gains in the S&P 500 this year. It might be hard to spot these trends, given the larger weakness that have been seen in small-cap in 2019. It seems that many of the market’s concerns are semantic in nature and it is often possible to view these types of small-cap companies in a completely different light when they are referred to as “growth” stocks.
Inevitably, mega-cap company’s like Apple, Inc. (NASDAQ: AAPL) or Exxon Mobil (NYSE: XOM) simply cannot match the growth prospects that are present in companies with a smaller market capitalization. Since these companies have already ready a period of “maturity” in their earnings growth rates, these types of stocks tend to be viewed as advantageous by investors with portfolio strategies that are more conservative.
As a result, it should be clear that different asset classes are likely to perform better in different types of market environments. According to many analysts, certain periods are often thought of as a preferable time to invest in small-cap stocks. But it should also be understood that these types of instruments tend to require active strategies with limited position sizes in order to avoid unexpected (and largely unnecessary) losses.
