S&P 600: A Benchmark for Small-Cap Stock Investing
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S&P 600: A Benchmark for Small-Cap Stock Investing

Investing
4 Min.

S&P 600 is a small-cap stock index by Standard & Poor's. Stocks must have a $850 million to $3.6 billion market cap to join. Investors can track it with ETFs. Small-cap stocks offer growth potential and are less analyzed by professionals, making them hidden gems.

Basics

Standard & Poor's manages the S&P 600, an index of small-cap stocks. It lists 601 stocks with an average market capitalization of $1.5 billion. To qualify, companies must have a market cap between $850 million and $3.7 billion, avoiding overlap with larger S&P indices.

The S&P 600 focuses on 3%-4% of US equities and mainly includes sectors like financials, industrials, tech, healthcare, and consumer discretionary, while fewer are in utilities and communication services. It's similar to the Russell 2000 but narrower in scope.

S&P 600 ETFs

Investors can't directly trade an index, but they can use exchange-traded funds (ETFs) to access the S&P 600. Leading ETF providers like BlackRock's iShares, State Street's SPDR ETFs, and Vanguard offer options.

Investors favor these ETFs for the growth potential of small-cap stocks. When companies outgrow the index's criteria or merge/delist, they exit. Here are some S&P 600-tracking ETFs as of July 2, 2022:

  1. Invesco S&P SmallCap Value With Momentum ETF (XSVM):
    • Launched: 2005
    • Market value: Over $598 million
    • Expense ratio: 0.39%
    • Top holdings: Fresh Del Monte Produce, Conn's, Olympic Steel, Cross Country Healthcare, Group 1 Automotive.
  2. iShares Core S&P Small-Cap ETF (IJR):
    • Launched: May 22, 2000
    • Assets: Over $61 billion
    • 30-day avg. volume: Approx. $4.4 million
    • Expense ratio: 0.06%
    • Top holdings: BlackRock Cash Fund, Southwestern Energy, Agree Realty, Omnicell, Rodgers.
  3. Invesco S&P SmallCap Momentum ETF (XSMO):
    • Launched: 2005
    • Assets: Around $138 million
    • Expense ratio: 0.39%
    • Top holdings: SM Energy, ServisFirst Bancshares, ExlService Holdings, Civitas Resources, Coca-Cola.
  4. SPDR Portfolio S&P 600 Small-Cap ETF (SPSM):
    • Launched: 2013
    • Assets: Over $3.9 billion
    • Expense ratio: 0.05%
    • Top holdings: Southwestern Energy, Agree Realty, Omnicell.

Advantages of Investing in Small-Cap Stocks

Growth Potential

Investing in small-cap stocks offers significant growth potential compared to large-cap giants like Microsoft, Apple, and Wal-Mart, which already generate over $100 billion in revenue. Small-cap companies often double or triple their sales annually because they start from a smaller revenue base. This means that small-cap software companies, for instance, have a higher chance of delivering substantial returns over the next decade compared to Microsoft.

Outperformance

Small-cap stocks often outperform because they receive less attention from professional analysts, making them opportunities for investors under Wall Street's radar. Large mutual funds, managing billions in assets, have rules limiting their investments in individual companies, making small-cap stocks insignificant in their portfolios.

Diversification

Due to their unique characteristics and behavior compared to mid-cap and large-cap stocks, small-cap stocks provide diversification benefits. This diversification can be a significant advantage for investors.

Investing Challenges

Investing in small-sized companies can yield higher returns but also involves challenges. Many such companies in the S&P 600 have limited reach and can be impacted by a weaker dollar, potentially affecting earnings and stock prices. Small companies, often young startups, offer growth potential, but they may have unproven business models, less experienced management, and limited financial resources.

Risks of Investing in Small-Cap Stocks

Small-cap stocks come with several specific risks to consider:

  1. Volatility Risk: Small-cap stocks tend to swing more wildly than large-cap stocks due to the uncertain long-term future of small firms. If you invest in small caps, be prepared for this volatility and ensure a long-term horizon to weather the ups and downs.
  2. Business and Default Risk: Small-cap companies carry higher business and default risk. They often have unproven business models, inexperienced management, and limited financial resources, making them vulnerable to economic downturns, rising costs, and competition from larger firms.
  3. Liquidity Risk: Small-cap stocks are less liquid than large caps. Buying and selling them can impact their prices as they attract less interest. This can lead to buying at higher prices and selling at lower prices than expected.
  4. Lack of Coverage: While small-cap stocks offer hidden opportunities, they lack coverage from Wall Street analysts and institutional investors. This makes it harder to obtain quality research and information, requiring more time and effort for analysis. Embracing uncertainty is essential when investing in small caps.

Conclusion

Investing in small-cap stocks can provide significant growth potential and diversification benefits. However, it also comes with specific risks such as volatility, business and default risks, liquidity risks, and lack of coverage. Investors should consider their risk tolerance and do their due diligence before investing in small-cap stocks.

Standard & Poor's 600 Index (S&P 600)