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Small Cap Stocks should be part of any balanced Portfolio


Effective use of your funds is more important today than ever before, and to be effective means mitigating risk as much as possible.

To accomplish that, funding should always be split across various investment vehicles, mixing low risk, low return options with higher risk, higher return to create a balanced portfolio that is not vulnerable to any individual market or industry failure.

One such investment vehicle is the small cap stock market. Small Cap Stocks (short for small capitalization stocks) simply means the stocks of smaller companies, usually those with a market value less than around US$ 2 Billion. The market valuation is easy to determine, being a product of the number of shares on the market multiplied by the value of each share.

They are no different to any other stock being traded on markets across the world, with buying and selling done in exactly the same way, however, because they reflect the values of small companies, they do behave differently than stocks of those larger, established organizations.

These smaller companies have more room to grow than already large established businesses, and they can often grow quickly. This means the share price is often more volatile, offering greater scope for larger, quicker profits.

As with all investments, risk and reward are balanced out here, as smaller, newer businesses are also more likely to fail. This means that while the stock price can rise dramatically generating profits, it can also fall just as quickly incurring losses.

We must always have those risks in mind when thinking about small cap stock investments.  

There are several reasons why small cap stocks represent a fantastic opportunity for the individual investor.

1. Profit or Dividend

There are two ways to earn a profit from stock investments, a rise in the stock value itself, or a dividend payment.

A rise in stock value is the familiar profit that most will understand. Stocks are bought at a specific price, through business growth, whether that be a new product or overall performance, the value of the company increases, represented by an increase in the stock price.

For investors, they can then sell stock, with profit being the difference between buy and sell prices. Of course, if a stock falls in value, that same difference represents a loss.

A dividend is an additional payment for each share that is held, a reward for investing in the business, and usually, but not always, reflects the profitability of the business. Not all stocks receive a dividend, and as it is somewhat tied to performance, even those that pay dividends may not do so every year.

In the case of small cap stocks, very few pay dividends, instead they tend to use profits to reinvest for growth, such as new product lines or improved capabilities.


Profit or Dividend

A dividend is an additional payment for each share that is held, a reward for investing in the business, and usually, but not always, reflects the profitability of the business. Not all stocks receive a dividend, and as it is somewhat tied to performance, even those that pay dividends may not do so every year.

In the case of small cap stocks, very few pay dividends, instead they tend to use profits to reinvest for growth, such as new product lines or improved capabilities.


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Making money from shares is earned in two ways.
2. A market where smaller investors have the advantage

 One of the most attractive things about small cap stocks for the individual investor is this is one area where the large investors are at a disadvantage.

Small cap, as we have discussed, means companies with market valuations below US$ 2 Billion.

That usually translates into a lower price per stock, which is why some refer to the market as penny shares, but it also applies to the number of shares available to buy.

It doesn’t always apply of course, but in general, the number of shares on the market are relatively low when compared to the established businesses and global brands that markets often focus on.

The reason this makes a difference and puts the institutional investors at a disadvantage is because of how they purchase stocks and enter positions in the market. An institutional investor would normally make stock purchases in a company is large blocks.


Investing in Small Cap Stocks

For a large cap company, this is not an issue, as even blocks of a million shares still represent a relatively small amount of the total available shares.

By contrast, a large purchase like that for a small cap company can represent a significant market share, enough to trigger regulator filing requirements and other legal issues that can drive the purchase price up significantly.

For the majority of individual investors, those levels will never be reached.

This allows smaller investors to take full advantage of the opportunity small cap stocks represent without institutional investors influencing the market in the way they do elsewhere.


3. Small Cap Stocks have historically performed better

While there is increased risk compared to large cap stocks, with smaller companies more likely to fail and lose stock value, there are also greater rewards.

Historically, small cap stocks have outperformed large cap by around 2.7% per annum on average. This may seem like a small amount, however in the context of a long-term investment portfolio it can make a significant difference.



A $50,000 investment an average of 7% PA return, would see an investment value of $155,000 after 30 years. The same investment at 2.7% higher, a 9.7% return per annum, would result in a final value of $195,500. That final value is over 20% higher than the first. For long -term investments for retirement provision, that better performance can have considerable impact.

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4. Small cap stocks provide diverse opportunity

Small cap stocks cover every industry imaginable, allowing a tailored investment portfolio that takes advantage of economic conditions in specific industries.

There are risks, the dot com boom at the turn of the century showed how volatile small cap stocks can be. They rose fast, but it dropped again equally as quickly.

But the diverse range of stocks available allows investors to take positions in any industry or market with a relatively low initial investment.


Investing in a small cap stocks

This ability to seize opportunities in emerging products, technology or ideas is a key advantage of small cap stocks. While risks increase, the potential for growth within such emerging markets and technology means that returns on investment can be larger too.

5. Managed or individual investing

Deciding to include small cap stocks in an investment portfolio is sensible if the aim is a diverse and balanced approach. There are several ways to do this for a small investor, the first being using a broker to buy stocks yourself.

 This could be through a full-service traditional broker, who will also offer advice on your investment strategy, or through an online broker. Here, in general, you are left to make your own choices with no intervention in your decisions.

Another option is a managed account, where broker’s use professional traders to manage funds in an account on the owner’s behalf. 


This approach needs careful consideration, ensuring that the risk profile adopted meets an account owner’s expectations, while a track record of success should also be visible.

For those wanting to take advantage of the opportunity small cap stocks offer, but lack investment experience or time to research suitable stocks, an appropriate managed account can be a useful option.

6. Risks of small cap stock investing

As with any investment, there are always risks. Small cap stocks are, compared to large cap investments, more volatile, offering the potential for an increased return.

This is because small cap businesses have more room for growth. They also tend to be younger organizations, and here is where the increased risk appears.

These businesses are statistically more likely to fail than the established, large cap organizations. Failing can mean several things, whether it is the failure of a particular product or service, common for companies seeking to establish a position in a market, or perhaps the failure of the organization itself.

Because newer, growing businesses tend to have the high turnover to debt ratios, setbacks can be catastrophic and result in complete collapse.


investment strategies for small cap stocks

For investors, depending on the severity of the issue, this could mean stock price falling below the price they were purchased for, generating a loss.

How much depends on the severity of the price fall. In the case of the organization completely collapsing, stock prices will fall to zero, meaning the entire investment would be lost.

Small cap investments should be made with care, research of the company involved, and with comprehensive research, market evaluation and understanding, much of the risk can be mitigated.

As with any stock investment, however, there is always a risk element when purchasing small cap stocks.

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7. Conclusion

Stock investments are one of the most popular components of any investment portfolio. While some stick to large cap companies that offer lower risk and lower returns, there is a place for small cap stocks.


The ability to take advantage of industry growth, new technology or innovative ideas through smaller companies can see impressive profits for any portfolio.

It must always be viewed in context with the increased risk though, and in this sense, small cap stocks do require a level of understanding of the company and its performance that many individual investors may lack. 

With so many stocks to choose from, finding the right investment can also be time-consuming, and this is why for small cap investments, the managed approach has much to offer.

Looking to get started in Investing:

1. Schedule an appointment (Conference Call) with an Investment Manager

2. Submit a Managed Discretionary Account (MDA) application with Walker Capital Australia.

3. Open a trading account with the Walker Capital Australia’s executing broker.

4. Select from our range of investment strategies and choose your asset allocation between the choices of accounts.

5. Once all accounts are opened, and funds have been chosen, our team gets to work and begins trading.


We welcome you to give our team a call to discuss your investment goals and objectives.

You can call Walker Capital Australia on +61 2 8076 2210, and we’ll see how we can help you achieve your investment goals.