SMALL-CAPITALIZATION STOCKS have a
reputation for being the market's speed demons. That's not
entirely accurate, since there are plenty of small, stodgy
banks and rust-belt manufacturers in the group. And there
are times -- like much of 1997 and 1998 -- when small stocks
suffer from the perception that they're too risky in
volatile markets. But companies with a market value below $1
billion can by nature grow more quickly than bigger
companies. And the good ones can post explosive earnings
that drive double-digit returns for investors.
There are several indexes that
track small-cap stocks. Probably the most widely referenced
is Frank Russell Co.'s Russell 2000, which tracks 2,000
companies with an average capitalization of $592 million.
Companies in Standard & Poor's small-cap index, the S&P 600,
average about $639 million in market value. Most people,
however, consider any company below $1 billion a small cap.
Small-cap companies tend to have
correspondingly small revenues. And that means many of them
have either just started up or are poised to expand their
markets, either geographically or with new products. You
probably had not heard of Metro One Communications in March
of 2000 when it traded at $14.94. MTON provides call centers
for the large cap telecoms like AT&T & Sprint of which you
have certainly heard of. MTON became swept up in the telecom
boom and quickly appreciated to a high of $64.87 a share an
increase of 334%.
The difference in size had a direct
impact on how quick MTON was able to appreciate versus the
large caps. The smaller company also experienced much wider
price swings. And you can bet it will be much more
vulnerable to any inkling of an economic downturn than the
mighty large cap stocks. But Metro’s incredible performance
would have been a great sweetener to any diversified
Rapid growth is clearly the appeal
of small-cap stocks. But they are not for the fainthearted.
Little companies are significantly more volatile than big
companies -- meaning there's much more downside risk. And
they don't pay dividends as often, a real detriment for
investors who want some income.
There are other risks as well. When
the economy is uncertain -- as it was for most of 1998 --
investors looking for safety and stability will often
abandon small caps for blue chips. Also, because small
companies have fewer shares outstanding, their price
movement is necessarily more erratic. When good news hits
the tape, investors clamoring to get in will drive the price
up quickly. When bad news hits, the opposite is true, and it
can sometimes be difficult to get out. Because fewer Wall
Street analysts cover these stocks, there's also less
reliable information on them. That means bad news can strike
out of the blue, plundering stock prices overnight.
For all of that, however, most
investors -- especially young ones who have the time to make
up any losses -- want exposure to small caps. As we saw with
Metro One, the upside potential is simply too great to pass