Small-cap companies are defined as those with a market capitalization of less than Rs. 500 crore. The majority (95%) of Indian corporations are categorized as small-caps.
Small-cap stocks are those issued by companies with a rank higher than 251 that typically perform well in the early stages of the economic recovery.
What are small-cap stocks?
Stocks of small-cap companies that are offered for public trading on a stock exchange are known as small-cap stocks or small-cap equity.
Small-cap stocks are often a good option for investors who want to get a higher return on their investments. Additionally, those who have a high risk tolerance and can tolerate exposure to market risks may think about making this investment.
These stocks are prone to market risks when the market is in a low phase because of their volatile nature. However, by including investments that are supportive of the market in their portfolio, investors can reduce the risk factor related to small-cap stocks.
Features of Small-Cap Stocks
Individuals who want to invest in small-cap stocks should learn about these following features –
- Volatility: Small-cap stocks are notoriously volatile due to the significant impact that market changes have on their NAV. These stocks, for instance, perform well when the market is strong but typically underperform when the market is weak.
- Risk factor: Small-cap stocks are subject to market fluctuations because of their reliance on it. Small-cap stocks are a risky investment because they are more likely to be impacted by market downturns and take longer to recover from them.
- Returns: One of the best investment options for yield is small-cap stocks. By producing over 100% returns, they are thought to have the potential to become multi-baggers.
- Cost of Investment: Investors must additionally pay an annual fee known as the Expense Ratio in addition to the initial cost of purchasing small-cap shares. 2.5% of the average AUM is the maximum allowable amount for the same. Investors would see better returns from their small-cap stocks if they invested in those with the lowest expense ratios.
- Investment Horizon: Indian small-cap stocks are available for both long- and short-term investments by individuals. To spread the risks involved with them and to achieve significant returns, investors should choose small-cap shares with a long investment horizon.
- Taxation: Section 80C treats the profits made from the redemption of small-cap shares as income. If the shares were held for less than a year, the gains generated are subject to short-term capital gain tax at a rate of 15%. Gains from shares held for longer than a year, however, would be subject to long-term capital gain tax at a rate of 10%.
Reasons to Invest In Small-Cap Stocks
An investor should think about investing in small-cap stocks for three compelling reasons.
Those reasons are –
- taking advantage of the small-cap companies’ growth potential.
- obtaining high-quality stocks at a discount due to market inefficiencies.
- Possibility to purchase small-cap shares at reasonable prices unaffected by major 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
Small-cap companies typically exhibit higher rates of organic growth than large-cap firms. Small-cap companies, in contrast, have a higher potential to develop and raise capital over time. This particular factor benefits small-cap stocks and significantly raises their growth potential.
- Fairly priced
When it comes to investing in the best small-cap stocks, major institutional investors must abide by certain restrictions; this directly limits their ability to drive up stock prices. Due to their advantage over institutional investors, small investors can now purchase small-cap shares at reasonable prices.
- Low priced quality stocks
Due to possible market inefficiencies, small-cap companies are undervalued and their stocks are undervalued. With a little diligence and market analysis, investors can take advantage of these inefficiencies by purchasing high-quality stocks that are being offered at a discount.
Associated Risks of Small-Cap Stock
The risks associated with investing in small-cap stocks in India are listed below –
- is vulnerable to market risks, which can only be long-term insulated through appropriate asset allocation and portfolio balancing.
- provides investors with comparatively less liquidity and makes the sale process difficult.
- determines whether they are a viable investment option takes time and research.
Small-cap stocks produce higher returns, but they also carry a heavy risk load. Such investment options would not be suitable for conservative or risk-averse investors. They should be aware that they are unable to take advantage of small caps’ higher returns.
Alternative Investment Options
On the other hand, investors may choose a less risky investment option if they lack a strong enough risk appetite to withstand market fluctuations.
These alternative investment options are available to investors:
- Large-cap stocks –Large-cap stocks are defined as the shares of the top 100 performing companies.Large-cap stocks are less vulnerable to changes in the market. Because of this, they are appropriate for long-term investors with a moderate to low risk tolerance.
- Hybrid Funds –Hybrid funds and balanced funds are additional alternative investment options that investors can consider. The ideal balance of debt and equity is provided by hybrid funds. Investors can directly diversify their portfolios to spread risk and receive guaranteed returns.
- Government Securities – Government securities are also available for purchase by individuals. They are typically government-issued debt instruments, making them suitable for risk-averse investors seeking consistent and guaranteed returns.
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