Small cap companies - a potential option for investment.

small and mid cap companies are considered the backbone of the economy in terms of business capacity, job creation at local level and the overall growth of country. they generally encounter many bottlenecks, which hold them back from realising their true potential.

The problems generally small cap companies face are:

not -so- technologically developed

inability to tackle heavy budget constraints

limited access to finance

wide market penetration and high-end technology

poor infrastructure

Thus,Small cap stocks have a bad reputation. The media usually focuses on the negative side of small caps, saying they are risky, frequently fraudulent and lacking in quality that investors should demand in a company. Certainly these are all valid concerns for any company, but big companies (think Satyam and Worldcom) have still fallen prey to issues of internal fraud that virtually destroyed shareholder interest. Clearly, company size is by no means the only factor when it comes to investors getting scammed. In this article we'll lay out some of the most important factors comprising the good and the bad of the small-cap universe. Knowing these factors will help you decide whether investing in smaller-capitalized companies .

Small cap companies can prove to be very high yielding investments .Few advantages of small cap companies are:

1. Huge growth potential

Most successful large cap companies started at one time as small businesses. Small caps give the individual investor a chance to get in on the ground floor. Everyone talks about finding the next Reliance or L&T , because at one point these companies were small caps - diamonds in the rough if you will. Had you possessed the foresight to invest in these companies from the beginning, even a modest investment would have ballooned into an extravagant sum.

2. Most mutual funds don't invest in them

It isn't uncommon for mutual funds to invest hundreds of millions of dollars in one company. Most small caps don't have the market cap to support this size of investment. In order to buy a position large enough to make a difference to their fund's performance, a fund manager would have to buy 20% or more of the company. heavy regulations on mutual funds that make it difficult for funds to establish positions of this size. This gives an advantage to individual investors who have the ability to spot promising companies and get in before the institutional investors do. When institutions do get in, they'll do so in a big way, buying many shares and pushing up the price.

3. They are often under-recognized

This third attribute of small caps is very important. What we are saying here is that small caps often have very little analyst coverage and garner little to no attention from Dalal street. What this means to the individual investor is that, because the small cap universe is so under-reported or even undiscovered, there is a high probability that small cap stocks are improperly priced, offering an opportunity to profit from the inefficiencies caused by the lack of coverage devoted to a particular area of the market.

The Drawbacks to Small Cap Investing

As with any investment, small caps are not without inherent drawbacks. These include:

1. Risk

Despite the fact that small caps demonstrate attractive characteristics, there is a flip side. The money you invest in small caps should be money you can expose to a much higher degree of risk than that of proven cash-generating machines like large caps and blue chips.

Finding time to uncover that small cap is hard work - investors must be prepared to do some serious research, which can be a deterrent. Financial ratios and growth rates are widely published for large companies, but not for small ones. You must do all the number crunching yourself, which can be very tedious and time consuming. This is the flip side to the lack of coverage that small caps get: there are few analyst reports on which you can start to construct a well-informed opinion of the company.

2.The Bottom Line

There is certainly something to be said for the growth opportunities that small cap stocks can provide investors; however, along with these growth opportunities come increased risk. If you are able to take on additional levels of risk relative to large-cap companies, exploring the small cap universe is something you should look into. Alternatively, if you are extremely risk averse, the rollercoaster ride that is the stock price of a small cap company may not be appropriate for you.

In different investing style one of the popular investment style is small cap vs large cap.

3.Small Cap vs. Large Cap

Some investors use the size of a company as the basis for investing. Studies of stock returns going back to 1925 have suggested that "smaller is better." On average, the highest returns have come from stocks with the lowest market capitalization (common shares outstanding times share price). But since these returns tend to run in cycles, there have been long periods when large-cap stocks have outperformed smaller stocks. Also, early on, small cap stocks had bigger premiums and were more expensive to buy and sell, but isn't easily captured in historical analysis, and in reality likely skewed total return for investors.

Small-cap stocks also have higher price volatility, which translates into higher risk.Some investors choose the middle ground and invest in mid-cap stocks with market capitalizations between $500 million and $8 billion — seeking a tradeoff between volatility and return. In so doing, they give up the potential return of small-cap stocks.