Investor Toolkit: The role of small and large cap stocks in your portfolio

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on the fundamentals of successful investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Successful investors own big and small companies.”

Shares of large, well-established companies have rebounded well after the 2007-2009 market crisis. Investors sometimes refer to these companies as “large cap stocks.” That’s because they have a market “cap” (that’s short for “capitalization,” or total value of shares outstanding) of several billion dollars or more.

Some investors now wonder how long this large cap resurgence can go on. They wonder if they should sell their large cap stocks and instead buy “small caps.” These are smaller companies with a market capitalization below some arbitrary figure, such as $1 billion.

  • Look beyond market cap to judge a company’s investment quality. Large cap stocks can be leaders in giant fields with expanding potential. Or they can be wounded behemoths in declining fields. The investment quality of small caps varies even more. They range from near-worthless promotional issues to leaders in small but fast-growing fields.

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    To tell good companies from bad, you have to look at a variety of factors much subtler than market cap. They include earnings, dividends, the strength of the corporate balance sheet, the strength of the company’s products, customer loyalty or fickleness, and so on.

  • A large cap stock may have a high or low price per share. Remember, a company’s market cap is equal to the total number of shares outstanding multiplied by the price per share. However, a large cap stock can have a low price per share if it has many shares outstanding.

Investment opinion: To succeed in today’s highly volatile markets, you’ll need to own shares in a variety of companies of varying sizes. Here’s one thing your best choices will have in common: each will be about the right size to succeed in the business they are in.

Next Wednesday, October 27, 2010, Investor Toolkit will look at the pros and cons of short selling stocks.

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