Small-cap companies and volatility generally go hand in hand. By nature, companies with a small market capitalization are volatile in nature. That's because these businesses are still growing into their potential and don't have the deep pockets that their large-cap counterparts have accumulated for the tough times, according to Fidelity Investments. If you don't mind the roller coaster ride that small-cap stock prices are likely to take, you've got plenty of companies to choose from, considering the thousands of stocks that trade in the Russell 2000 small-cap index.
A company's market cap reflects its size based on the amount of shares that are traded relative to the market value, or stock price. A common but nonofficial yardstick defines small-cap companies as those with market capitalization of less than $1 billion, according to Fidelity Investments. Small-cap companies do grow up eventually. Atlanta Capital Management portfolio manager Chip Reed noted in a 2013 article on the "Wall Street Journal" website that a small-cap stock that was worth $1 billion when he bought it evolved into a large-cap stock worth $8 billion.
Stock market volatility occurs when stock prices exhibit dramatic and seemingly unexplained upward and downward swings. Since volatility is not driven by fundamentals, such as a company's earnings and revenue, it can be unwarranted and may be a result of investor emotions, such as fear. Measuring volatility in small-cap stocks might be easier than you think, as the CBOE Russell 2000 Volatility Index is designed to do the work for you. The average volatility between January 2004 and March 2013 was 27.1, for example. Gauge the level of volatility in small-cap stocks using the average as a benchmark.
One of the challenges you'll face in unearthing volatile small-cap stocks is finding quality investments. Volatility is a reflection of risk, and the more volatile an investment is, the greater the risk you're taking. Small-cap stocks expose you to more risk of financial loss versus large-cap stocks and bonds, according to a 2011 article on the "USA Today" website. It's not uncommon for small-cap stocks to conduct a percentage of their business in countries with economies that are still developing, which increases the likelihood for setbacks.
While small-cap stocks are generally highly volatile, exceptions to the rule will make it tougher for you to discover these companies. For instance, in the first three and one half months of 2013, small-cap stocks were trading essentially in lockstep with the broader stock market. Small-cap stocks advanced nearly 12 percent during this period, while the Dow Jones Industrial Average, which represents trading in 30 large-cap stocks, was only about 1 percent behind that performance, according to a 2013 article on the "Barron's" website.
- Fidelity Investments: Balancing Market Capitalization
- The Wall Street Journal: Warning Signs for Small-Cap Stocks
- Barron's: Smallcap Stock Volatility Index Hits All-Time Low
- USA Today: Emerging Markets and Small-Cap Stocks Add Risk to Your Portfolio
- The Wall Street Journal: IndexIQ Announces June 2013 Distributions for IQ US Real Estate Small Cap ETF (ROOF)
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.