Why Canadian Small Caps should be a small part of your portfolio

We think that small caps should not make up the bulk of your diversified portfolio — but you can benefit from making the best Canadian small cap stocks a smaller part of your holdings.

We generally feel that most investors should hold the bulk of their investment portfolios in conservative securities from well-established companies. This means holding a total of 15 to 25 well-established, dividend-paying stocks, chosen mainly from our “Average” or higher ratings, and spreading your holdings out across most if not all, of the five main economic sectors.

However, some investors choose to add more aggressive or speculative stocks to their holdings in their pursuit of bigger, faster gains. That can involve holding some of the best Canadian small stocks.

Understanding how we look at the best Canadian small cap stocks

We recommend a number of small-cap stocks in our Power Growth Investor newsletter, and we comment on others in our Inner Circle mailings, in response to questions by members. We also recommend some higher-risk investments in our Spinoffs & Takeovers publication.

Our Aggressive Growth Portfolio selections in The Successful Investor and Wall Street Stock Forecaster tend to be more highly leveraged and more volatile than our Conservative recommendations, and they can give you bigger gains and bigger losses. Their higher risk may be due to financial leverage, or to the risks facing their industry or particular situation. Still, our Aggressive Growth stocks are typically less aggressive than the picks in, say, our Power Growth Investor newsletter.

We can be wrong on any of our stock recommendations, of course. When we’re wrong on an aggressive stock, losses are likely to be larger than on a well-established stock.

Ultimately, the percentage of your portfolio that you should hold in either conservative or aggressive investments depends on your personal circumstances. An investor with a longer-time horizon or without the need for current income from a portfolio can afford to invest some money in aggressive stocks.

We look at many stocks before singling out our aggressive favourites, and we try to choose those with as much underlying value and as many hidden assets as possible. This is the best way to cut risk for conservative and aggressive investors, alike.

Note that if you decide to include some aggressive stocks in your portfolio, we do advise picking a selection of at least four or five stocks, from different sectors and with a mix of value and growth picks. You should also be quicker to sell aggressive stocks than conservative stocks. With aggressive stocks, you’ll want to monitor our advice on the stock in our newsletters and weekly Hotlines and be ready to sell at any time. That’s a crucial part of success in aggressive investing since change comes more quickly here than elsewhere.

Use these tips to pick the best Canadian small cap stocks and keep your portfolio profitable

It bears repeating — limit small cap stocks to a smaller part of your portfolio: Ultimately of course, the percentage of your portfolio that should be held in either conservative or aggressive investments depends on your personal circumstances. An investor with a longer time horizon, or without the need for current income from a portfolio, can invest more money in small cap stocks.

Downplay small cap stocks in the broker/media limelight: The limelight fosters bloated investor expectations. Small cap stocks that are talked up like this may seem like ideal candidates for big gains, with lots of investors getting on board. But when stocks fail to live up to those expectations, brutal downturns follow. Applying this aspect of our conservative philosophy to an aggressive portfolio leads us to stay out of most new small cap stocks. Rarely will you find a new issue to be one of the best Canadian small cap stocks in your portfolio. Most new issues come to market when it’s typically a good time for the company or insiders to sell. That’s rarely a good time for you to buy.

Look for hidden value in best Canadian small cap stocks: Hidden assets can consist of real estate or underused brand names. For example, companies often carry their real-estate assets on the corporate books at their purchase price, even though their value may have multiplied many times over the years. The purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the historical purchase price remains unchanged on the balance sheet.

More broadly, use our three-part Successful Investor approach for all of your investments, including the best Canadian small cap stocks

  1. Hold mostly high-quality, dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

What is your approach to investing in aggressive small cap stocks while also protecting your portfolio from losses?

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was published on Feb. 15, 2022 and is republished on the Hub with permission. 

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