How do you double your money in a short timeframe?
While there is no guaranteed way to do that, small cap stocks at least offer the potential to do it. With smaller size comes greater potential returns, which is one of the reasons why Nobel Prize winning economist and portfolio theorist Eugene Fama’s five factor stock valuation model (market risk, size, value, profitability, and investment) includes a “size premium.”
The reason smaller stocks offer higher potential (not necessarily actual) returns is because they make up a small percentage of the universe they operate in. If the economy is worth $10 trillion and a company has a $5 trillion market cap, then that company’s stock is going to need a seriously massive amount of investment to move at all. A $5 million company by contrast would need only a tiny percentage of the economy’s wealth in order to double.
So, small cap stocks can double more quickly than large cap stocks. In this article, I’ll explore how I’d invest $4,000 in small cap stocks to potentially double my money.
Image source: Getty Images
Focus on undervalued sectors
The first thing I’d do if I were looking to double my money in small cap stocks is focus on undervalued sectors. Tech stocks – even small cap ones – are often very pricey. The pickings are a little cheaper in value sectors like financials and energy.
Consider Baytex Energy (TSX: BTE) for example. I don’t own this stock, but I own its larger cousin Suncor Energy, a TSX energy stock that I started buying last year and continued buying this year.
Why highlight Baytex Energy instead of Suncor? Put simply, as a small cap, it has more capital gains potential in a “best case scenario.”
Baytex Energy stock is currently pretty cheap, trading at 5.6 times earnings, 0.61 times sales, and 0.47 times book value. This is much cheaper than Suncor Energy, but on the flipside, Baytex does not have as entrenched a market position as that company does. Suncor is a true energy giant with exploration and production (E&P), refining, marketing and gas station operations. Baytex by contrast is a pure play E&P.
BTE stock suffered a severe beatdown during the 2015–2020 oil bear market. At one point the stock was down 99%! The problem was that BTE was laden with debt, which caused it to suffer worse earnings performance than other oil companies at the time. However, BTE managed to reduce its debt to $930 million from a peak of $2 billion thanks in part to the oil bull market of 2022. Today BTE’s debt level is back up over $2 billion. However, its shareholders’ equity is much higher now. Overall, I’d say this stock is worth a look.
Diversify
If you want to get some diversification in your portfolio right away, without having to go out and pick 20-plus stocks, you could go with an index fund such as the iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). As a broad market index fund, XIC has some small cap exposure, but not so much that investors will experience extreme volatility. In all honesty, getting small cap exposure through such a vehicle is probably ideal for most investors.
Some desirable characteristics of the XIC ETF include low fees (0.05%), ample diversification (220 stocks), and high liquidity. These are the exact qualities you want in an index fund and XIC has them in spades.
Foolish takeaway
While I’m not personally trying to double my money with small cap stocks, I can appreciate that some people want to do so. If you’re one of them, consider the ideas in this article as a basic guideline to doing so without taking on too much risk.
