What is small cap

Small caps - everybody’s darling or just for the brave?

Annette de los Santos, April 30th, 2021

What are small caps?

Like large caps and mid caps, a company or a share is classified as a small cap (cap = short for market capitalization) according to its market capitalization. It is calculated using the following formula:

Small caps, like mid caps, are among the so-called. Minor stocks. German small caps do not necessarily have to be listed in a stock market index. At this point we only consider small caps that are listed in Germany either in the SDAX (derived from Small Cap) or in the TecDAX.

Generally, companies with a Market value of up to € 500 million counted among the small caps. However, small caps with a market value of € 100 million are already represented in the SDAX.

The SDAX lists the 50 small companies that follow the MDAX companies in terms of market capitalization and stock exchange turnover. As with all other German stock indices, only companies in the Prime Standard can be considered. The Prime Standard ensures special international transparency requirements, such as the publication of quarterly reports in English.

in the SDAX there is a wide Distribution according to different industries. In contrast, im TecDAX mainly small tech companies listed. The dynamics of these indices are naturally greater than that of the DAX and MDAX.

Opportunities and risks of investing in SDAX and TecDAX

Many of the small caps listed in the SDAX and TecDAX are still relatively young, there are no comparative figures from the past, and planning depends on unpredictable factors. Also the usual ones Analysis metrics are often not applicable to small caps. Investors can therefore seldom base their investment decisions on expert analysis. You have to focus more on topics such as needs analyzes, sales markets, future prospects for products and quality of management.

In accordance with the not insignificant profit and exchange rate fluctuations in the start-up phase, entry at the wrong time can lead to high losses in the meantime. Investors then need long-term stamina and short-term return expectations are not met. Because of the generally low capital base, small caps are also subject to a higher risk of bankruptcy.

On the other hand, there are also high return opportunities with small caps. The US capital market researcher Jeremy Siegel has compared the returns of American small and large caps for over four decades. The small caps performed better with a return of 14.8% p.a. than large caps with a return of around 12% p.a.

However, there are experts who are of the opinion that the much vaunted return opportunities are not as great as they are often claimed. In the German indices, the MDAX (mid caps) has recently outperformed large and small caps.

The performance of small caps

Small cap investors suffered a major setback when the Internet bubble burst in 2000. Among the small caps listed in the German indices, however, there are very solid companies that have been established in the market for years and have good to excellent growth opportunities. Below you will find a little about this Overview with examples of small capsthat have done well over the past 2 years.

Price increase of selected small caps in comparison


share


Closing price




(€), 10.01.18



Closing price




(€), 10.01.20


Price gain (%)

index
Hornbach Holding 43,35 78,10 80,2 SDAX
Fielmann 56,45 67,70 19,9 SDAX
Carl Zeiss Meditec 70,75 108,90 53,9 TecDAX
SAP SE 86,79 105,84 21,9 TecDAX


Source: finanzen.net and boerse.de, as of January 5, 2021

Other companies, such as Jungheinrich or Aixtron SE, performed significantly worse in the last two years than in previous years or had to accept significant price fluctuations and constant or falling prices. So it is not a blanket term to speak of a segment full of winners.

Conclusion on investing in small caps

Overall, small caps are not suitable for security-oriented investors because of the risks described. According to experts, return-oriented, risk-conscious investors should not add more than 15% to 20% to their equity portfolio. In order to better diversify the risk, they also recommend investing in index funds (ETFs) over direct investments in individual stocks (“stock picking”). A long-term investment horizon and diversification also reduce the risk of losses.

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