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About Small Cap Growth Investing

written by: Tim Plaehn•edited by: Jason C. Chavis•updated: 6/23/2010

Small cap growth investing is an area where individual investors can have an advantage over the big Wall Street investment houses. Small cap growth investors are looking for the next Apple or Walmart!

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    Small Cap Growth Investing Definition

    Let us take the term small cap growth investing and break it down, back to front. First, the term refers to stock and stock market investing. Picking out stocks that meet specific criteria. Growth stock investing involves finding those companies that have revenues and income growing faster than the the other companies in their industry and and the overall stock market. Finally, small cap refers to a company's market capitalization or the total value of a company's outstanding stock. A common designation for small cap stocks are companies with market capitalization between $200 million and $2 billion. Contrast this with large cap stocks which have market caps from $10 billion to over $200 billion.

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    Advantages of Small Cap Growth Investing

    The small cap stock arena is one area where individual investors can have an advantage over the large institutional money managers. Large cap stocks are followed and analyzed by dozens of Wall Street analysts and the big investment firms have their own in-house analysts to dig into to the nuts and bolts of companies like Apple, IBM and Coca Cola. However, the big guns of Wall Street spend very little time and effort looking at small cap companies.

    The individual investor has the ability to do the research and find small cap companies that Wall Street and the mutual funds have overlooked. The Motley Fool website notes that small cap companies are not followed by Wall Street until an event brings them to the attention of institutional investors. Individual investors can find these "pearls of potential profit" before they are discovered and the share price takes off to the moon. Small cap growth investors have the potential to find the next Apple, Microsoft or Starbucks.

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    Finding Small Cap Growth Stocks

    To find hidden opportunities in small cap growth stocks, investors must do their own research. Heavy reading in the financial pages and websites is required. A stock screen for companies with market capitalization of $200 million to $1 billion, a PEG--price to earnings growth--ratio of less than 1.0 and projected 5-year earnings growth greater than 15% produces a list of about 200 stocks. Use a stock screener to find the fast growing companies that have attractive stock prices. The PEG ratio is a useful tool for this.

    When you find some interesting stocks, read the quarterly earnings reports for the last year and listen to the management conference calls that discuss those reports. The Investor Relations page of a company's website will have links to this information. Listen to the management, read and analyze the numbers and form your own opinion on the company and stock potential. You must use your critical mind to perform these tasks. It is easy to fall in love with a stock, especially after you own some shares. You are looking for companies that have growth potential and sustain their growth path.

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    Alternatives for Small Cap Growth Investing

    If you do not have the time or inclination to research individual companies, a small cap growth mutual fund can do the work for you. Historically, small cap growth stocks have had multi-year periods of significantly higher performance than large cap funds. Here are some small cap growth stock mutual funds recommended by Money magazine:

    And an ETFs:

    Always do your own research before investing in any stock, bond or mutual fund.