Building your Small Cap portfolio
Building a small cap portfolio, whether or not it exists within a bigger portfolio, such as a swag of Telstra and CBA shares that you inherited from your aunt, shouldn’t change your approach.
How many Small Cap stocks should you buy?
We recommend that you buy seven to 10 Small Cap stocks, but you don’t need to own these straight away! You can build up a Small Cap Share Portfolio over months, or even years.
Why seven to 10 Small Cap stocks?
This is not a risk-free approach. Nobody can guarantee that the first stock you pick will shoot the lights out. You need some diversity to avoid the risk of having a number of good ideas but only having bought a dud. Remember you should diversify with seven to 10 Small Cap stocks in your porfolio.
Liquidity is a factor in entry and exiting Small Cap stocks.
It’s also important to buy slowly to mitigate liquidity factors, which refers to how hard it is to get in and out of a stock position. We’re talking 10 per cent to 20 per cent of your anticipated holding to start with, and then you wait. Say you intend to invest $2000 in one Small Cap stock, start off by investing up to $400. Patience is the key.
A quick note should be made in relation to exiting positions. If you have a big Small Cap holding, it is often best to take some profits early. It is always best to anticipate news, rather than react to it. This is easier said than done, but if you are reacting to the news, then essentially it’s too late. The bigger your share holding the more important it is to anticipate news.
We often say that our preferred allocation is for cash (0-25%), Small Caps (20-30%) and Big Caps (50-75%). You can use our Blue Chip Value Report with our Price Targets on over 40 Blue Chip stocks to manage your Blue Chip portfolio.
But it’s also possible to invest solely in Small Caps, where you can get a well diversified selection. This is definitely a strategy for those who can handle more risk and volatility. It’s important for us to emphasise that we also recommend that people do not borrow to invest at all, particularly not in individual small caps. And remember to diversify.
What are you hoping to achieve with your Small Cap stock portfolio?
You are looking for two or three winners, which are currently small companies (or Small Caps), but which have the capacity to become much bigger just by doing more of what they’re currently doing. The flip side is that you will have two or three poor performers. The key here is that your losses are limited, but your gains are not.
We are looking for cheap Small Cap stocks.
The point about investing in ASX Small Caps is that they tend towards being cheap, because they’re small. Buying as cheap as you can will protect your portfolio risk.
What about dividends with Small Cap stocks?
The more a company is achieving its operational goals, the more important dividends as a component of your investment return. When you are buying a Small Cap stock you are buying for a certain amount of dividend, plus a certain amount of hope value. If there is no dividend, then it’s all hope value. This is not a bad thing, but you need to realise that there is much more risk involved in the latter.
In a portfolio context, dividends help to pay fees, taxes and provide a tangible return on your money.
It's easy to tell which of our Small Cap stocks with dividends. We show the forecast dividend yield for each of our small cap stocks.
How long am I holding onto my small cap stocks for?
We are never going to time our entry and exit points perfectly. Our preferred holding period is in the words of Warren Buffett, “forever”. But. Unfortunately very few stocks will have that capability to maintain growth through good times and bad. In the Australian tax situation, holding on for a year makes most sense, because your capital gains tax exposure will be reduced. Rarely do we look for trading situations.
What is your own investment risk profile?
Your investment risk profile will help you choose the Small Cap stocks that are right for you. Under the Radar Report does the hard work for you and we have filtered out over 2,000 Small Cap stocks and have selected 100 Small Caps that our independent analysts have found value in. But every investor has their own level of risk profile. When you read our Choosing the right ASX Small Cap Shares it illustrates this.
A Spec Buy (speculative buy) rating means that it is more speculative that a stock we rate as a Buy. Don't miss our our best ideas list for the stocks we believe are a good investment if you are in a buying phase and and full stock research.
It is also a good idea to think about how you have made money in the past and correlate that experience with any money making ideas.
Under the Radar Report is independent. Our Small Cap analyst team is experienced. Our recommendations are based on the stocks that our independent analysts have selected after thorough research and reviews. Our report has a proprietary process in order to select for Small Caps that match our criteria. You can read through our Small Cap Shares Investment Philosophy to read about this. In addition to analysing company announcements and financials, we spend a great deal of time speaking to the management of the small cap company.
Why is it important to start a share portfolio?
Over the long term, the stock market is still the biggest generator of wealth around. The stock market in an index sense will reflect what’s going on in the overall economy: not just GDP growth, but the changes in the mix of the economy. It reflects the importance of technology. Property can never do this because it’s simply bricks and mortar.
The ASX stock market reflects technological changes, but often in a way that is different to what people perceive at the outset.
In 1999 people were buying anything dot.com, but the real industry that has been revolutionised is banking. The cost base in banking has been permanently reduced by 20 to 30 percentage points, relative to where it was. And as we all know, these cost reductions haven’t been passed on to the consumer!
Diversity with Small Cap
The great thing about shares is that you can buy diversity with a handful of dollars. You can buy a media company, a miner, a technology company, a bank and a hospital owner. If you own a big house in Randwick or St Kilda, you’re stuck with that area’s characteristics, and it’s expensive and time consuming to get out!
Buy quality companies and the right price
The most powerful thing in investing is buying quality companies at the right price; the second is dollar cost averaging: investing in stocks over time when the price is high and when it’s low. Combining the two should generate returns of 10 per cent plus over the long-term.
Why Blue Chip Stocks and Small Caps are important
There is a place for both investing in Blue Chip stocks and Small Caps in a portfolio. Blue Chip stocks at the big end of the spectrum definitely have the advantage of being less likely to go broke. The financial crisis proved that point. But at the Small Cap end, although there is more volatility, there is more diversity, and more potential to boost your portfolio’s returns.
There are over 2,200 listed companies on the ASX and the biggest seven represent about half of the $1.3 trillion dollar market capitalisation. These are the big four banks, Rio Tinto and BHP Billiton and Telstra.
The median market cap of the top 200 companies has a market cap of close to $2 billion. While almost 90 per cent of the companies, numbering just under 2000 have a market cap of less than $300 million, which is what we define as small caps. It’s these small companies that Under the Radar focuses on because they are not widely covered. We think that they should represent at least 25 per cent of a share portfolio.
It’s must easier for a company with a market cap of $100 million to double and triple in value, than it is for one that is worth $1 billion.
Building a small cap portfolio, whether or not it exists within a bigger portfolio, such as a swag of Telstra and CBA shares that you inherited from your aunt, shouldn’t change your approach.'