The stock market overall has been on a phenomenal winning streak over the past several years, and small-cap stocks - defined as companies with less than $2 billion in market capitalization - have certainly been part of that positive trend.
In fact, the Russell 2000 Index, which tracks small caps, is up nearly 7% in the past month.
With the recent run-up, is this a great time to invest in small-cap stocks?
Let's take a look...
Small-Cap Stocks: Easy to Overlook...
Small-cap stocks are easy to overlook, because they're not as well known. Most people have heard of Dow component McDonald's Corp. (NYSE: MCD), but how many people have heard of WidePoint Corp. (NYSEMKT: WYY)?
But that's part of the attractiveness of small-cap stocks. Because they're not well known, most casual investors do not purchase small-cap stocks, which can lead them to be undervalued.
The good news is that with some positive press about the company, small-cap stocks that aren't commonly recognized can become more well known, boosting share purchases - and thus driving the stock price higher. So if you bought in before that time, you stand to profit handsomely.
Still, small-cap stocks are not without risk. They tend to be thinly traded, meaning that the market volume on a day-to-day basis is not nearly as high as it is with large-cap stocks. In a nutshell, that translates to the potential for wild swings in the market. If you own small-cap stocks, you might find yourself riding a financial rollercoaster for a while.
Nonetheless, those risks may be worth it in the long run, and here's why...
... But a Worthwhile Investment
Overall, the upside benefits of small-cap stocks far outweigh the potential risks. In fact, small-cap stocks have outperformed their larger counterparts in the recent bull run. During four of the last five years, small-cap stocks have been the top-performing asset class.
"Investors are nowhere near as allocated into small-cap stocks as they should be," said Mark Matson, founder and chief executive officer of Matson Money. "There is an amazing bias towards large, blue-chip stocks. It's human nature. We tend to be more comfortable with things we're familiar with."
If you wish to follow Peter Lynch's "Buy What You Know" investing philosophy, there are a few small-cap stocks that are fairly well known. These include OpenTable Inc. (Nasdaq: OPEN), the online restaurant reservation system; Callaway Golf Co. (NYSE: ELY), the golf accessories retailer; and Winnebago Industries Inc. (NYSE: WGO), the RV manufacturer.
However, as noted previously, most small-cap stocks are not household names. Biotech companies, for instance, are very popular with some savvy investors, even though most people who don't dwell in capital markets regularly have never heard of them.
This is why we've put together a guide for finding small-cap stocks to buy now. You see, you don't need to study ambiguous chart patterns, watch business news all day, or pore over valuations. Sid Riggs, Money Morning's Small-Cap Investing Specialist, shares his strategy for identifying the best small-cap stocks of 2014 - in five simple steps.
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