Companies with a market capitalisation less than Rs. 500 Crore are categorised as small-cap companies. Over 95% of Indian companies are considered as small-caps.

This type of companies holds a rank above 251 and tends to perform during the initial phase of economic recovery and the stocks issued by such companies are termed as small-cap stocks. 

What are small-cap stocks?

Small-cap stocks or small-cap equity are stocks of small-cap companies that are publicly traded in a stock exchange.

Investors, who want to generate higher returns from their investments, tend to find small-cap stocks a suitable option for them. Additionally, individuals who have a high-risk tolerance level and can bear exposure to market risks may consider this investment option.

These stocks are volatile in nature and are prone to market risks when the market is going through a low phase. However, investors can cushion the risk factor associated with small-cap stocks by adding market-friendly investments in their portfolio.

Features of Small-Cap Stocks

Individuals who want to invest in small-cap stocks should learn about these following features –

  • Volatility: The NAV of small-cap stocks tends to be heavily influenced by market fluctuations, making them volatile in nature. For example, these stocks perform well during the high market phase but tend to underperform when the market is struggling.
  • Risk factor: The dependence of small-cap stocks on the market makes it susceptible to its fluctuations. These stocks are more prone to be affected by the market recession and take time to recover from the same; this makes small-cap stocks a risky investment option.
  • Returns: Small-cap shares are counted among the top-yielding investments options. They are considered to have potential to emerge as multi-baggers by yielding over 100% returns.
  • Cost of Investment: Besides the initial cost of acquiring small-cap shares, investors also have to pay an annual charge called the Expense Ratio. The upper limit of the same is 2.5% of the average of AUM. Investors who invest in small-cap stocks with the lowest Expense Ratio would generate better returns from them.
  • Investment Horizon: Individuals can invest in small-cap stocks in India for both long-term and short-term. However, investors should opt for small-cap shares which come with a long investment horizon to spread the risks associated with them and also to generate substantial returns.
  • Taxation: The returns generated on the redemption of small-cap shares are treated as income under Section 80C. The gains thus generated are subjected to short-term capital gain tax at the rate of 15%, if the shares were held for less than a year. However, gains generated from shares that were held over a year would attract long-term capital gain tax at the rate of 10%.

Reasons to Invest In Small-Cap Stocks

There are three compelling reasons why an investor can consider putting their money into small-cap stocks.

Those reasons are –

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  • Benefiting from the growth potential of the small-cap companies.
  • Availing quality stocks at lower prices owing to the inefficiencies of the market.
  • Opportunity to avail small-cap shares at fair prices which are not influenced by large financial institutions.

Major Advantages of Small-Cap Stock

Individuals who invest in the best small-cap stocks investors avail these advantages mentioned below –

  • Greater growth potential

When compared to large-cap companies, small-cap companies tend to have a better organic growth rate. Unlike them, small-cap companies have a greater potential to grow and acquire capital in due time. This particular aspect works in favour of small-cap stocks and enhances their growth potential to a significant extent.

  • Fairly priced

Major institutional investors have to adhere to certain limitations when it comes to investing in best small-cap stocks; it directly restricts their power to push the stock prices upwards. This offers small investors advantage over institutional investors and allows them to avail small-cap shares at fair prices.

  • Low priced quality stocks

Small-cap companies are under-recognised, and their stocks are under-priced owing to probable market inefficiencies. Investors can benefit from such inefficiencies with a little research and market evaluation by acquiring quality stocks that are being offered at a lower price.

Associated Risks of Small-Cap Stock

The risks associated with investing in small-cap stocks in India are listed below –

  • Is susceptible to market risks which can only be cushioned in the long-term through proper asset allocation and portfolio balancing.
  • Offers comparatively less liquidity to the investors and makes the process of sale cumbersome.
  • Requires time and research to determine their effectiveness as an investment avenue.

Though small-cap stocks generate better returns, they come with a significant risk burden. Risk-averse individuals or conservative investors would not be suited for such investment options. They should also understand that they cannot avail the benefits of availing higher returns through small caps.

Alternative Investment Options

On another note, if investors do not have a sturdy risk appetite to weather the market fluctuations, they may opt for a less risky investment option.

Investors can put their money into these alternative investment avenues –

  • Large-cap stocks – The shares of the companies which are ranked in the top 100 are categorised as large-cap stocks. Large-cap stocks are less susceptible to market fluctuations. This makes them suitable for long-term investors who have a moderate to low risk appetite.
  • Hybrid Funds – Investors can also explore hybrid funds or balanced funds as an alternative investment option. Hybrid funds offer a perfect mix of both debt and equities. It directly allows investors to diversify their portfolio to spread risk and avail assured returns.
  • Government Securities – Individuals can invest in government securities as well. Typically, they are debt instruments that are issued by the government and hence are suitable for risk-averse investors who are looking for steady and assured returns.

Whether it is small-cap stocks or Mutual Funds, investors should always opt for an investment avenue that suits their requirements and their financial standing.

Additionally, investors should take into account their risk appetite before investing and allocate their investments accordingly.

However, if individuals are not very well-versed with their market knowledge, they always have the option to seek professional assistance.