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Right now, it is important to reduce your portfolio’s risk because it is becoming evident that market risks are rising. Small Caps can help you reduce that risk.
Why is market risk rising? For one thing, global markets climbed last year after a reversal led by the US Federal Reserve from tightening to loosening, leading to falling interest rates. The S&P/500 Index has climbed 20% in the past 12 months. Consequently, there has been significant multiple or PE expansion, which means valuations across the board are stretched.
The coronavirus emanating from China is a real X factor in terms of its effect on growth, but on top of this there have been devastating bush fires in Australia and of course there is the ongoing trade war propagated by the Trump led US government against China.
These stocks are outside of the major indexes, which is what is defined as the market. Because of this, they have often have low market correlation, which means they don’t move in line with the market and so they can reduce your overall market risk.
When you buy the CBAs and BHPs of this world, you are buying a significant part of the market. When you buy the small cap Clover Corp (CLV), you are buying a stock that has some market risk, but it has greater risk relating to the growing market for Omega3 rich baby powder.
When you are looking to make money investing, it is always important to think about your overall portfolio risk. I can’t emphasise this enough.
With that in mind, let’s look at some small caps that can weather the proverbial storm. The factors that I’m looking for here are what Under the Radar defines as “Quality”. You can read about these criteria on our website in the news section, but they include balance sheet strength, cash flow, sales growth, management, industry competition, barriers to entry and customer base. Moreover, these are the sort of stocks you want to buy more of if they fall in price.
It’s worth remembering that to achieve diversification you will need more stocks. We advocate investors buy between seven to 10 stocks to get the benefits of reducing stock specific risk. Again, we expand upon this in our website.