Investing in Small Cap Stocks
Per Hansen, Investing expert at Nordnet
Here are some of the points that investors can take into consideration when investing in new and small cap companies that are, or are planning to be listed:
- Investing in companies that are soon to be listed, is high risk. When new companies are portrayed by themselves and their advisers, the opportunities often seem attractive. Beware of too much bias praise.
- The smaller a company is, the less backing it may have to carry the company’s future. At the same time, there may be a shorter history than the companies that are already listed on the stock exchange. New companies are still growing and could either fail or be successful.
- Large risks must be offset by large returns. The difference in return between 5 companies that have already been listed for many years, compared to 5 companies being listed now, will fall out to the already listed companies, if you have to measure returns in relation to risk in the future in, for example, 3 years. This must be reflected in a very low price at the time of introduction. It is a good idea to be a bit skeptical of the share price.
- The smaller the companies, the greater the risk that it is the private investors who will have to carry the listing home. This could result in price fluctuations in the share. On average, new and larger companies sell 90% of new shares to long-term institutional investors and 10% to private individuals. When it comes to very small companies, the distribution is called 0/100. In the short term, this means that there is a lack of stable investment money, which means, among other things, that the share price can have a larger fluctuation, in small companies.
- It is therefore important to understand the rules of the game in connection with a stock exchange listing. Optimism and hype is great at the time of introduction, and many assume that demand exceeds stocks for sale so much that there is free money to be had. However, free money does not exist. Part of the visible interest is artificially created and disappears as quickly as it comes. It is a good idea to consider whether what you are buying is also something you can see yourself investing in, in addition to the first listing day.
Key Take Aways
Lack of liquidity remains a struggle for small cap stocks, especially for investors who take pride in building their portfolios on diversification. This difference has two effects:
- Small-cap investors may struggle to offload shares. When there is less liquidity in a marketplace, an investor may find it takes longer to buy or sell a particular holding with little daily trading volume.
- The managers of small-cap funds close their funds to new investors at lower assets under management (AUM) thresholds.