In the world of investing, where attention often gravitates toward large-cap, well-established companies, microcap stocks are often overlooked. However, there is a growing consensus among financial experts that 2024 may be the year for microcap stocks to shine. These pint-sized companies, typically with a market capitalization of less than $300 million, are gaining attention for their potential to deliver substantial returns. Here’s why microcap stocks are coming under the spotlight.
Solid GDP Growth Projected to Continue
According to the latest advance estimate, the U.S. economy saw a robust annualized growth rate of 4.9% in the third quarter of 2023. This figure marks the highest level of expansion since the final quarter of 2021, surpassing market expectations that had forecasted a 4.3% growth rate. It also represents a significant rebound from the 2.1% expansion witnessed in the second quarter of the year, as reported by tradingeconomics.
Consumer spending played a pivotal role in driving this impressive growth, registering a substantial increase of 4%. This surge in consumer spending is the most notable since the fourth quarter of 2021. The uptick can be attributed to heightened consumption across various sectors, including housing and utilities, healthcare, financial services and insurance, food services and accommodations, as well as nondurable goods with prescription drugs leading the way. Additionally, recreational goods and vehicles also contributed to this noteworthy growth in consumer spending. These are all sectors strongly represented by microcap companies.
Lower Valuations and Growth Potential
Microcap stocks are frequently undervalued or undercovered by analysts – if they are covered at all – creating opportunities for astute investors. The lack of attention can lead to pricing inefficiencies, where the market has yet to recognize the true value of these companies. When investors identify these undervalued gems and the market catches on, it can result in significant price appreciation.
Fundstrat’s head of research, Tom Lee, recently projected a small-cap rally in 2024. Small caps, which typically have more short-term debt than other companies, could benefit from the cost of capital coming down as the Fed is expected to cut rates in 2024, he said.
Moreover, microcap companies are often in their early stages of growth. If they successfully execute their business plans, they have the potential to transition into mid-cap or even large-cap companies over time. Investing in these smaller companies early on can translate into substantial gains as they expand their operations and reach.
There are also perennial benefits to investing in microcaps:
Affordable Investment Opportunities
One of the primary reasons investors are showing more interest in microcap stocks is no surprise: their affordability. Microcap stocks are often priced at a fraction of the cost of their larger counterparts, making them accessible to a broader range of typically retail investors. With share prices in the single digits or lower, investors can buy more shares for the same amount of capital and potentially magnify their returns.
Well-run microcap companies remain attractive targets for larger corporations seeking to expand their market reach or acquire innovative technologies. When a microcap company is acquired, it typically results in a premium being paid to shareholders. This can lead to substantial returns.
Diversification is Good Insurance
Including microcap stocks in a diversified portfolio may reduce overall risk. Since microcap stocks often have low correlations with larger-cap stocks, they can provide a hedge against losses in a down market. Diversification across different market segments will almost always enhance overall portfolio performance and reduce vulnerability to volatility.
Economic Recovery Potential
As the global economy continues to recover from the impacts of the COVID-19 pandemic, smaller companies may benefit disproportionately from increased consumer spending and economic growth. Microcap stocks, being nimble and agile, can adapt quickly to changing market conditions and seize growth opportunities in a recovering economy.
Risks to Keep in Mind
While the potential for substantial returns is enticing, it’s essential to keep in mind the common risks associated with microcap investing:
Microcap stocks are notorious for their high volatility. Prices can experience significant intraday fluctuations in response to minor news events or shifts in market sentiment.
Lower trading volumes can make it challenging to buy or get rid of shares at a desired price, especially in larger quantities.
Microcap companies may have little publicly available information, making it harder to conduct due diligence.
Higher Risk of Business Failure
Smaller companies are more susceptible to business failure, and not all microcap stocks will achieve growth and success.
Still, as we move into 2024, market observers and economists alike say it’s worth keeping an eye on small-cap stocks, which may present lucrative investment opportunities that shouldn’t be overlooked.