Understanding Value Stocks, Small & Large Caps

Should you ever find yourself at a cocktail party with Warren Buffett, you may want to learn the language of value investing, which has grown to be one of the more popular practices in the market.

It’s a good idea to learn more for your own investment purposes, so here is a brief guide to value investment terminology:

Value stocks Value investors closely scrutinize and analyze the marketplace for anomalies, keeping an eye out for undervalued companies. Value stocks are stocks that investors believe are trading for less than they are worth. Value managers and analysts actively seek these stocks by essentially looking at the marketplace through a microscope, anticipating that they will eventually appreciate and outperform the market.

Of course, this is not a perfect science and investors stand to lose money sometimes. But value stocks are bought with a margin of safety, which means buying at a discount. By paying as little as possible for a stock that they anticipate will rise significantly, investors lower their risk while increasing their potential gain.

Small caps Small caps are not just headgear for children. In the investment world, small caps are stocks of companies that have small market capitalization. (Market capitalization is essentially a measure of how much the company is worth, based on the market value of a company’s outstanding shares and the stock price.) Small caps are typically newer companies and have a market capitalization under $2 billion.

Small-cap stocks have the potential for huge returns, as these smaller companies have a lot more room to grow. However, investors should be wary of risk because a company’s small size makes it more vulnerable to market fluctuations.

Large caps If small caps are companies with small market capitalization, large caps are companies with large market capitalization. Investors’ standards may vary, but large caps usually boast a market capitalization of over $10 billion. They are some of the world’s largest companies, including Wal-Mart (NYSE:WMT), Microsoft (NASDAQ:MSFT) and Procter & Gamble (NYSE:PG). Investors favor large-cap stocks that have strong earnings and healthy cash flow. Because these companies are so large, they can better withstand volatility in the market.