How to build a Small Cap Portfolio

Richard Hemming, editor of Under the Radar and his small cap analyst team give you a step-by-step guide to building your own small cap share portfolio, whether nor not it is part of a bigger equities 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?

First thing to say is that we recommend you ultimately hold seven to 10 small cap stocks, but the next thing to say is that you don’t need to own these straight away! You can build up a small cap portfolio over months, or even years, small cap stock by small cap stock, as prices allow.

Liquidity is a factor in entry and exiting small cap stocks. 

It’s also important to buy slowly to mitigate liquidity factors, which basically refers to how hard it is to get into and out of a stock position. We’re talking 10% to 20% 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.

Asset allocation. 

We often say that our preferred allocation is for cash (0-25%), small caps (20-30%) and big cap (50-75%). You can use our Blue Chip Value report with our Blue Chip 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.

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.

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 small caps is that they tend towards being cheap, because dah, 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 hold 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? It will help you choose the small caps 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 capstocks 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 well the need to read our research but reviewing our research and the risk in the company. 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. 

 

 

 

 



 

What you get

UTR Dashboard
As Seen In