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Small-Cap Stocks: What They Are & How They Work

Updated: Apr. 26, 2022By: Michelle Jones

The definition of small-cap stocks is a stock with a market capitalization between $300 million and $2 billion. Learn more about the characteristics of small-cap stocks and the pros and cons of investing in them.

Small Cap write on sticky notes isolated on Office Desk. Stock market concept
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What Is Considered a Small-Cap Stock?

Small-cap stocks are generally those with a market capitalization of $300 million to $2 billion. The market cap is the total number of outstanding shares times the share price. The dollar ranges associated with market cap classifications change periodically, usually upwards.

Pros & Cons of Investing In Small-Cap Stocks


  • Small-cap stocks often outperform large-caps, on average, as they have more room for growth.
  • Small-cap stocks often do well at the beginning of an economic recovery as investors become optimistic about the future of the economy and are willing to take on more risk.


  • Small-cap stocks tend to have more volatile share prices.
  • Many small-cap companies are not as well-established are larger companies, which poses potential risks in economic downturns. Small companies are more likely to fail during a recession.

Large-Cap & Mid-Cap vs. Small-Cap Stocks

Large-cap stocks have a market cap of at least $10 billion, while mid-caps are stocks with market caps of $2 billion to $10 billion. The Small-caps segment has market caps of $300 million to $2 billion.

Generally, the smaller the company, the less established or financially capable it is, and the higher the risk it is to invest. However, smaller companies usually have a greater potential for growth, and investors generally weigh risk versus reward in electing what investments to add to their portfolios.

Small-Cap Stocks vs. Penny Stocks

Some investors think small-cap stocks sell for low prices, but that isn't necessarily the case. Small-cap has to do with what the market thinks the company is worth based on how many shares are outstanding and how much those shares are trading for. Penny stocks are generally those trading for less than $5 a share, although some other companies may see their share prices drop temporarily. Penny stocks may be traded on a major stock exchange or

over the counter (OTC).

Investing In Small-Cap Stocks

Factors investors may wish to consider before selecting small-cap stocks to their portfolio are:

  • The company's revenue growth
  • It's earnings growth
  • Balance sheet flexibility

Many smaller companies are unprofitable and burn cash, meaning that funding issues could arise in the future. Small-cap companies with a large cash balance, and improving cash from operations (CFO) figures may be less vulnerable than those without those traits.

Other metrics or factors to look at include:

Companies with a large addressable market and whose stocks are on the rise are often more attractive. Many small-cap investors look for signs of a healthy, growing company.

Tip: Investors who invest in small-cap stocks have usually decided that the potential for significant growth is worth the greater risk of investing in small-caps.

How To Invest In Small-Cap Stocks

Investors can trade small-cap stocks just like do for any equity security by doing so through a brokerage account with a company like Robinhood, E*Trade or eToro. In addition to buying individual stocks directly, investors can also gain exposure to small-caps by investing in an exchange-traded fund (ETF) that tracks the Russell 2000 Index, or contains a different portfolio allocation to small-cap stocks. Many mutual funds also focus on small-cap stocks.

Should You Invest in Small-Cap Stocks?

When deciding whether or not small-cap stocks are right for your portfolio, it's a good idea to think about what the rest of your portfolio consists of. Diversification is important, and it might make sense to diversify stock holdings by investing in a mix of large-cap, mid-cap and small-cap companies.

Investors may also want to think about how much risk and volatility they can tolerate. Risk-averse investors or those who can't handle the stress of volatility may want to consider avoiding small-caps. On the other hand, if you can handle some volatility in exchange for the possibility of higher returns, it's worth investigating small-caps.

Important: The information contained here is purely for educational purposes and does not represent investment recommendations.

This article was written by

Michelle Jones profile picture
Michelle Jones is editor-in-chief for ValueWalk.com and a daily contributor for ValueWalkPremium.com and has been with the sites since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She lives in the Chicago area with her son, dog and two cats.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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