Investing Know-How: Small Capitalization Growth Stocks

Today we’re covering an advanced investment topic:  Picking individual stocks for your portfolio. This comes after you’ve established a base with an asset allocation plan and ETFs to cover all the major components of your plan.

MD Russell2000 2013Searching out small but publicly traded companies (on a major exchange, not a “penny stock” or pink sheet), can be fun and profitable! But it’s only for those with funds for long-term investing who are willing to dig into the research.

Let’s Play Pick-A-Winner!

Whether you have the necessary funds or not, you can play along with a virtual or paper trading account. Yahoo Finance offers portfolios where you can track one or more stocks as if you owned them. If you haven’t already, open a Yahoo finance account and set-up a Small-Cap Growth portfolio. There you can enter your virtual purchases and watch what happens to your practice account.

Once you understand how to identify, research and follow a small company’s growth, you may decide to transfer one or more of your virtual holdings to your brokerage account.

Millions and Even Billions of $$$ = Small-Cap???

Yeap. We’re not taking a flyer on cousin Joey’s garage start-up. Small-cap growth companies suitable for a well diversified portfolio are typically defined as:

Publicly traded companies with market capitalization below two billion dollars. Market capitalization is the price of the stock multiplied by the number of shares outstanding. The most commonly used index for small-caps is the Russell2000 (RUT) which currently has a median market-cap of $678 million and an average of $1,887 billion.

At Yahoo finance you can screen from 100 million to 1 billion. Screen Shot 2014-06-21 at 5.18.10 PM

Yahoo (and Google) quote summaries  will show the market-cap calculation, on a particular stock (middle of the right column):

Screen Shot 2014-06-21 at 5.26.48 PM

 

 

 

 

 

Use the screeners to identify all companies within a range of market capitalization levels or drill down further by sector, and key ratios.

But, why would you want to spend the time and energy looking at small, relatively new companies stocks?

If You Love Reading Balance Sheets and Income Statements…

First, it can be fun. If you enjoy learning about new businesses and anticipating how they help change the way we live, small company stories can be as exciting (and way more profitable) as a romance novel!

You’re looking for companies that have:

>> A very strong potential for income and earnings growth.

Most successful company’s growth chart ends up looking like a hockey stick:

And operating margins are high and on the rise. MD Hockey stick graph

>> A new or unique way to solve a common problem.

>> Competent Management.

Start-up entrepreneurs don’t always make the best managers for a growth stage company. You want to see some experienced folks in operations and finance.

>> A low price to earning ratio, debt less than equity and low institutional ownership.

>> High insider ownership (people who work there hold a lot of the stock).

You won’t find small-cap growth companies paying dividends since they reinvest their earnings to grow the company but they should have free-cash-flow to support their growth without excessive borrowing. Once they grow beyond small-cap you can expect them to start paying a dividend but that’s way down the road.

APPL chart1 Apple (APPL) is a classic example. They went from small to medium to large cap over more than 30 years of public trading and only started paying dividends in 2012 when some activist investors demanded they share some of their free-cash-flow since they had more than they could profitably reinvest.

Mainly, you’re looking for a 10-bagger, a home-run, a way to supercharge your portfolio’s long-term return. So, never start your investing career with small-caps. Start  with Exchange Traded Funds (ETFs), add a few safe, secure, large-cap dividend payers and then, when you have a decent sized, well diversified portfolio, add some spice with a few well chosen small-cap stocks — if you want to take your risk, and potential rewards, up a notch.

What do you think? Are you ready for some advanced investing or are you happy to keep adding to your ETF holdings? Either way will make you wealthy and financially free – if you follow the right guide.

Live Long and Prosper – Leah, the MoneyDiva.com

 

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