Small Cap Stocks - Should They Now Be Avoided?

The world's stock markets have taken a hammering in 2008 with pretty much every single listed company seeing huge falls in their share price. Both large and small companies have been affected but smaller companies have been hit particularly hard and are looking really weak, so is it now worth buying shares in these companies or not?

Well my own personal view is that these smaller cap companies should be avoided, at least for now. There are very few buyers out there generally, and the investors that are buying are predominantly buying shares in solid profitable companies that are most likely to survive the impending recession and be in a strong position when the economy recovers.

While there are a few smaller companies that are doing well and likely to survive the credit crunch, they are definitely in the minority. Furthermore even the ones that are profitable are still largely out of favour with investors because at the moment people are looking for safe shares to invest in, and this generally means the largest and most established listed companies.

There are also real fundamental problems with these smaller companies that are a direct result of the credit crunch. The vast majority of these companies rely on credit to grow their businesses in a healthy economy, but in this weak economy when people have less money to spend, a lot of these businesses need credit just to survive. However as has been mentioned in the news on numerous occasions, the banks just aren't lending money at the moment, which is a crippling blow for small businesses.

The secret to successful investing is to buy profitable companies at low prices and hold on to them for several years when you should hopefully see substantial gains. However at the moment you cannot be confident about any small cap companies because quite simply you do not know if they will still be in business in a few years time.

These are really tough times and smaller companies are finding it particularly difficult, so my own investing strategy is currently to ignore all small cap stocks and focus on the larger companies that have a long record of income growth and dividend growth. These companies are the ones best equipped to deal with the forthcoming recession.

By James Woolley