Before you decide to start buying shares from companies listed on the Johannesburg Stock Exchange, you need to know about the different index categories and how the companies listed in these categories differ based on their market capital. Generally, it is the listed companies that are the most popular among investors that end up gaining selling the most shares. These companies are usually listed in the mid cap index, but what many people don’t realise is that the companies that are listed small cap index are the soon to be prominent companies. While popularity might be a good indication about the profitability of investing, it is far from the only indicator.
Don’t overlook the small cap index. This is the first thing that must be said about this particular share index category of the JSE. While this index might not always be a big favourite among the investors, it is the place where you are going to see those up and coming businesses that are set to grow and make a big impact further down the road. Unlike businesses listed in the mid cap and the large cap, small cap companies are usually brand new to the JSE. They have just made their first big impact in their industry and they now have enough to be listed on the JSE.
What they might not have is an extensive history, which is normally the factor that makes investors a little shy. Companies listed in the small cap are not necessarily those who are taking a gamble, they are there because they know that they are building a business venture that is likely to yield some impressive results, but they could find that they need a little help to get to the next level. Selling shares in their company can be the best option they have to raise a little capital without the risk that comes with making serious debt.
Small cap companies can have a sound financial grounding, and they might be onto a very good idea, one that might just grow into a bustling enterprise in the years that follow.
Defining small cap shares
The JSE has three categories into which listed companies are separated. With hundreds of companies listed on the Johannesburg Stock Exchange, and with each one belonging to a different industry, the process of categorising companies is not as simple as looking at the work that they do and then grouping similar companies together. When categorising listed companies, the JSE looks at the market capitalisation or market cap of each company and then determines where they will be listed.
Read more about the JSE TOP 40
There are three possible categories into which companies can be split: small cap, medium cap and large cap. Companies with stocks that are ranked, on the local market, between 1 and 41 are considered to be small cap companies and they are, as mentioned before, either new businesses or they are small businesses.
Another way to determine where a company will be indexed is as follows:
- Small Cap: Market cap is below R 1 Billion.
- Medium Cap: Market cap of between R 1 Billion and R 10 Billion.
- Large Cap: Market cap above R 10 Billion.
So your small cap companies might be considered more for those investors who are looking to take a bit of a risk, with the possibility that their risk will yield a very handsome financial reward. When you are building up your portfolio, you should try to include companies from all 3 categories. A bit of variation can help with balancing out your potential risks.
Small caps have gained a bit of a reputation for being volatile, just as they are known for falling out of favour with investors ever so often. One moment the small cap company could be one of the best to buy from and the next the company could be forgotten. Until a company reaches the mid cap category, that uncertainty remains. But although there is a risk in investing in small cap companies, the reward can be more impressive than those of the mid cap and large cap. Before you set out to invest your money, it is best to find out exactly what your advantages will be, you need to find out where you will be benefitting and why.
The benefits of investing in the small cap shares
Small cap shares boast some of the biggest investment advantages, they are known to outperform some of the more established companies and yield an exceptional payout. These stocks and shares are a must for your investment portfolio. On the Johannesburg Stock Exchange, you will always find newcomers to the exchange so there will always be options. You will, however, need to be very smart, and work closely with your broker to make sure that you are buying favourable stock from a proper up and coming company instead of a fly by night.
When you have made the right investment choice, here are just a few of the benefits of investing in a small cap company:
- You can expect growth. Although your mid cap companies and your large cap companies might provide you with an instant profit, your small cap companies are a long term investment. Your stock broker is likely to reinforce the fact that you will need to be patient with these shares but with a very good reason: compared to the other indexes, your small cap is more likely to yield a profit that surpasses that of your mid and large cap. This is a great reason to have a mixture of shares in your portfolio, with some paying out quickly and others building up over time.
- The market is thinner than other markets. This means that you will have less competition when it comes to buying the shares that you want and this then leaves you with more options. This also means that you will get the first pick in shares that might draw public attention as the company grows. Buying the shares first means that your shares will increase in value as the company becomes more popular for investors. In the long run, you are sitting with a potentially large return on investment as the value of the shares will rise quite fast when investors see an opportunity.
- You won’t be caught up in infighting. Large cap companies can be notorious for infighting, with company owners battling it out should partnerships and such come to a messy end. Often, the more successful a company is, the more stress there is on the shoulders of the company owners. Should a company tank due to infighting, you will lose your investments. Small cap companies avoid this issue as they are most times just starting out and just finding their feet.
- Smaller companies are more likely to be acquired by larger companies. Instead of a large cap company starting up a new division, they will often look to small cap companies to find the division they are looking for and then buy the company. This is an advantage if you have invested shares in a small cap company because your shares can increase in value overnight!
In the interest of balance, and to help you get a well-rounded idea of what you can expect with your small cap investment, here are some of the disadvantages that you could come across:
- These shares can be a little volatile, both in their drastic increases and in their sudden drops in value. This is not exactly a massive disadvantage for everyone, but when you are adding a small cap company to your portfolio you will need to have the stomach for the volatility.
- The future is not always certain with small cap companies. Due to their nature of mostly being start-ups, small cap companies are obviously not immune to sudden changes such as closing up shop. While these companies might be looking at a great idea, there is always a chance that the market doesn’t respond to them as well as it should. This can prove to be the factor that ends the company before it has had the opportunity to take off.
- Dividends might be difficult to come by. Many smaller companies will need every cent to be put back into the business so that they can grow. This is partly one of the reasons why investing in a small cap company is a game of patience. Waiting for the company to grow and then taking profitable dividends is the norm at least that is what data and history reflect. This is not to say that the small cap company you are investing in is not going to pay out dividends, but it is something to consider.
- There is no set in stone guarantee that the company will grow. This means that your investment will never yield a profit and the dividends that you eventually receive will not be exactly what might have hoped they would be. This is also why you should be sure that your investment portfolio is diverse as depending on a steady income from the small cap might disappoint you.
As you can see, there are plenty of perks, and a few risks, associated with buy shares from the small cap index. But when you have arranged your portfolio the right way, the benefits will outweigh the risks and you might well end up with some very impressive dividends for your risks.
5 tips from the JSE for investing
Whether you are just starting out your investment portfolio, or if you are an experienced investor, you can always do with a few tips. The investment manners and techniques don’t exactly change from one day to the next, but you could always do with a few pointers to push you in the right direction.
Consider this before you make your next investment:
- Diversify, diversify, diversify! Unlike everyday business, when you are investing, you are looking at an opportunity to have your fingers in all kinds of pies. You can choose from a range of companies, from industrial giants to that interesting start-up. And to make sure that you are able to make a profit, the more diverse your portfolio is the better. Having diversity in your investments means that you can balance your risks the right way.
- Use volatility of the various markets to your advantage. Prices and the value of stocks fluctuate, that is the nature of investments. There are two types of volatility; high and low. Higher volatility means prices can change drastically in a very short period of time, while low volatility means that the value of the shares changes at a very steady pace. If you are investing for the first time, it could be best to avoid investing in a highly volatile environment.
- Choose a reliable investment service provider. It is the norm to pay a broker a small fee to manage your investments but should you end up with the wrong provider, the small fee you pay could end up being a factor that harms your long term investment. Be sure to ask questions before you choose your manager and never be afraid to question service fees if you are concerned. The right broker will play open cards with you.
- Know your investment horizon. This refers to the amount of time you are expecting to hold a portfolio or a particular investment. For those looking to take a risk, their investment horizon is likely to be much shorter than those who are looking for that long term dividend pay-out.
- Make your money work for you by using a method known as compounding. Instead of taking your dividend and calling it a good day, reinvest some of that money back into your portfolio. You will end up saving more and making more in the long run and this method can help you reach your investment goals!
Small cap shares have just enough risk to become an exciting place to make your investments. With the right choices and a carefully planned investment portfolio, you will be able to soon see a return on the money you invest. For a good start to investing you should read as much as possible about the JSE and empower yourself with knowledge.
Is it time to talk to a broker? If you are ready to invest then the answer is absolutely yes! With our directory and our experienced brokers, we can assist you in making sound financial investments.