Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week’s question: How do I find those small companies that may grow into winners? What criteria matter for small caps with little or no earnings and sales? Again, thanks for all the insight. — Kevin Investing shouldn’t feel like gambling, especially when managing long-term investments. If you’re looking for a fledgling company with potential, you need to understand the risks. Discovering the next Nvidia is extremely difficult to do. Nvidia went public in January 1999 and had a market cap of around $300 million. The chipmaker is now the second-most valuable U.S. company with a market cap of $3 trillion. Investing in small-cap companies can sound appealing since many are still in their early stages of growth and, theoretically, offer more growth opportunities than mature large caps. However, putting your money into smaller companies with little to no earnings — or even sales, for that matter — involves a high degree of speculation. These less-established businesses carry a higher risk of failure. But if they succeed, they can deliver significant growth and high rewards for investors. The CNBC Investing Club does not engage in speculative investing. It’s a risky game that does not align with how Jim Cramer’s Charitable Trust is managed. The Trust is the portfolio of 31 stocks that we use for the Club. While touting Nvidia for a long time, the company and the stock were much more well-established when Jim first added it to his Trust in 2017. Small-caps — which Fidelity defines as companies with market values between $300 million and $2 billion — typically have fewer financial resources, limited access to capital, and often rely heavily on debt. All three make it harder to endure economic downturns. Their stocks also tend to have lower trading volumes, which can make them more volatile and difficult to trade. While small caps did have some spotlight moments in 2024, they didn’t last for long. Their biggest rallies came during market rotations in July and November when investors briefly shifted their focus away from the tech giants and toward smaller companies. The July surge kicked off the week of Jul. 9 after the June consumer price index report showed inflation cooled, providing a cushion for the Federal Reserve to cut interest rates. That caused investors to rush to interest-rate-sensitive small caps, pushing the Russell 2000 , the benchmark for the group, up 12.8% over that month , tripling the gains of the S & P 500 , according to a CNBC report. A similar rally happened the first week of November after the presidential election and an interest rate cut reignited interest in small caps with the Russell 2000 surging 8.57% to end the week . A week later that rally reversed and eventually investor enthusiasm faded in the group as the megacaps continued to deliver strong earnings and dominated the headlines. Jim does believe there’s a place for small-cap speculation, particularly for younger investors. However, when dealing with early-stage companies that are still unprofitable, there’s not much of a safety net. Unlike established companies, like Club name Costco , that have a proven business model, strong earnings, and consistent growth that investors can depend on, speculative investments require a different approach. Here are some quick stats about small caps, according to a Morgan Stanley note in October: Small-cap indices have very high turnover. In the Russell 2000 , there are only 56% of the same members today versus 2019. This compares to 81% for the S & P 500 . Of today’s active members, 25% were a result of an IPO (initial public offering) or SPAC (special purpose acquisition company) in the last five years. Small caps also tend to trail the performance of the broader market. As of Feb. 27, the Russell 2000 has gained 8.6% over the past 12 months versus the S & P 500’s 19% advance. If you’re going to take on such a risk, you need to be prepared for the possibility of a total loss. That’s why, in the early stages of evaluating a company, qualitative analysis is key because the numbers often don’t look that great. Qualitative analysis focuses on non-numerical factors that can influence a company’s success, especially when financials are limited. Understanding the business model, leadership team as well as the company’s industry position and their competitive strategy, can help gauge a company’s potential. This is particularly important for speculative investments where financials may not reflect the company’s true value. Here are four questions to answer before investing in a speculative small cap: 1. How good is management? When it comes to investing in small caps, the leadership team is everything. In a young, fast-growing company, strong executives can turn potential into profit. But by the same token, weak leadership can sink the business before it ever takes off. You want to see a management team with a clear vision, a solid track record, and the ability to navigate challenges. You can start by researching the leaders of the company by looking at their backgrounds to gauge their experience in the industry, past successes, and experience in similar roles and whether they’ve built a successful business before. Another key factor is how well they manage money and their balance sheet needs. Can they allocate resources wisely or are they burning cash without a clear plan? Does the company need to keep selling stock to raise cash? Corporate governance also plays a key role. This refers to the rules and practices that keep a company accountable and transparent. A well-run company with disciplined governance is more inclined to stay on track and deliver strong returns for investors. 2. Is there a market opportunity for growth? Small-cap companies tend to focus on niche markets with plenty of room for growth. So understanding the market opportunity can help investors determine whether a company has the potential for gradual expansion. It could be that these companies are innovators that may shake up entire industries. It’s possible that with thorough research, investors can spot undervalued companies that have growth potential. The key questions to ask: What is the potential for business growth in their niche? What is their total addressable market? Does this company have a clear path to profitability and long-term success? A promising market opportunity increases the likelihood that a small cap can scale and sustain its growth and potentially become a much larger player in its industry. 3. Does the company have a moat? A company’s moat is like its secret weapon: it keeps competitors from taking customers and eating into profits. For small-cap companies, a strong moat can either determine whether they have long-term success or will get clobbered by bigger players. A small cap with a solid competitive edge is more likely to grow and grab market share and eventually turn into a much bigger company over time. Some even become prime acquisition targets for larger firms. The way to spot a strong moat is to look at the company’s market position. Does it dominate a niche or offer something unique that’s hard to copy? Is their product or service proprietary? A company with a well-defined market position is more likely to create lasting value and keep growing for years to come. 4. Is there much analyst coverage? Smaller stocks often attract less interest from institutional investors and analysts, which could make it more difficult for everyday investors to do proper due diligence. Analysts tend to have deep insight into a company and can offer helpful analysis about the health of its business. Some of the information they’re privy to may be difficult for a regular investor to find. They may also have proprietary tools to analyze the stock’s prospects. Yet Wall Street often operates in a herd mentality. Much too often, many analysts’ assessments on a stock tend to be similar, so if one firm buys or sells, others tend to follow. On the flip side, if there isn’t a lot of analyst coverage, there probably won’t as much attention on the stock and therefore will be less subject to volatility. The same idea goes for institutional ownership, which includes mutual funds, hedge funds or pension funds. If there is increased institutional activity, that could create huge price fluctuations in the stock given these institutions often have large share transactions. 5. What are the company’s funding needs? Before investing in a small-cap stock, take a hard look at its cash position. Most don’t have the same access to funding as big corporations, which means they might struggle to finance new growth, keep operations running smoothly, or survive tough economic times. If they do secure funding, it may come at a higher cost since lenders see small caps as riskier, so they charge more to borrow. That higher cost of capital can eat into profits and slow down growth. And if a company takes on too much debt, it could jeopardize its financial stability. To gauge whether a small cap is on solid financial footing, some questions to ask: How much cash does the company need and what will it be used for? Will the funding lead to real revenue and profit growth? If the company isn’t profitable yet, when does it expect to break even? (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Traders work on the floor of the New York Stock Exchange on Feb. 13, 2025.
Danielle DeVries | CNBC
Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries.
This week’s question: How do I find those small companies that may grow into winners? What criteria matter for small caps with little or no earnings and sales? Again, thanks for all the insight. — Kevin
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