Small-cap companies can yield some of the biggest rewards in your portfolio, but they also carry some of the biggest risks.
In this clip from Industry Focus: Tech, host Dylan Lewis is joined by Motley Fool contributor Todd Campbell to explain the basics of small-cap stocks and what investors need to know before investing in them.
A full transcript follows the video.
This video was recorded on Sept. 22, 2017.
Dylan Lewis: Todd, before we really get into the companies, why don't we broadly talk about small-cap tech stocks a little bit, and maybe just, what's a small-cap stock, for listeners who don't know?
Todd Campbell: Small-cap stocks are exciting ways for investors to get involved in companies that could be truly disruptive. These are companies that are reshaping industries that have been around, in some cases, a generation or more. Typically speaking, we're talking about smaller companies in the younger stages of their development. With that comes risks, and as a result, most advisors and others will tell you, don't overweight your portfolio toward small caps, because they do tend to swing much more broadly than a company like Coca-Cola.
Lewis: So with that in mind, if you're thinking about how to invest in small caps, it's certainly something that you might want to have some exposure to, but it's not something you want to go whole hog into. So it's maybe a portion of your portfolio. Within that, I think it's smart to diversify and have several different small-cap plays. We talk about how a well-rounded portfolio for general purposes has between 10 and 15 stocks at least, and I think that might be good guidance for people interested in investing in small caps.
Campbell: Yeah. Dylan, I'm a diversified investor. You probably are, too. I obviously have healthcare stocks in my portfolio, including biotechnology -- technology is right in the name, so it's not that big of a leap. But I probably have 20% or so because I take on a little more risk in my portfolio in small caps. But like you said, getting much more than that in the portfolio could expose you to much wider swings during tough times.
Lewis: And I like to think about small caps as an opportunity for the individual investor to be kind of a venture capitalist. VCs tend to invest in dozens of different companies, making small bets across all these different small companies with the hopes that a couple of them really pan out. You have the opportunity to do that on public markets with small-cap stocks, because these are companies that have really big growth profiles and large runways ahead of them. But they are far more volatile. So that's why you want to spread your bets.
Campbell: Yeah, with a caveat. You get that growth, but you pay a price for it.
Lewis: I think something else worth noting with small caps, we didn't hit this definition earlier, typically we're talking about companies between the $500 million and $2 billion market cap. There are soft cutoffs with microcap, small-cap, midcap, and large-cap. That's generally where you'll hear that term applied.