Small caps are companies with a “market cap” (the value of shares they have outstanding) below $250 million, or some other arbitrary figure.

Many investors think of the “small cap group” as the place to look for aggressive investments, such as junior companies that will develop into seniors and make huge gains for investors. Some small caps will indeed turn out that way, but they’re a minority. In fact, small caps are a widely varied bunch.

The top small caps are well-established giants within small but growing fields. However, many small caps are start-ups that have yet to make their first profit. Some succeed brilliantly, and these are the hot small cap stocks we aim to help you spot in our Stock Pickers Digest newsletter, but lots of others go broke. Then too, some small caps are former large-cap companies that have terminal problems. They trade as small caps on their way to zero.

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Right now, small caps as a group offer above-average potential. That’s because small caps, good and bad, have fallen out of investor favour during the current stock-market decline. As a result, some offer tremendous value, and could turn out to be tomorrow’s hot small cap stocks.

Top small caps will likely pay off over time

Small-cap stocks are a lot riskier than large caps. They are also much more volatile. One bad quarter of earnings, or the loss of a major contract, for example, can quickly cut a firm’s share price. That’s why we view even the best small-caps as holdings for the aggressive component of your portfolio.

We always base our recommendations on a small cap stock’s investment quality. We look for sound companies that stand to benefit as the economy continues to improve. We also look for companies with proven management and long-term growth plans. It’s an approach based on company fundamentals, rather than trading or market timing.

That’s opposed to so-called concept stocks, which mainly include start-ups or companies that look to profit from next week’s or next year’s investor fad. These companies can put on a great performance in a good year, when they guess right. In the long run, though, they’re likely to cost you money.

We always advise investors not to overindulge in any one group of stocks. That’s especially true of small caps, which can be more volatile than other investments. But selected high-quality small-cap stocks can boost your portfolio returns. For our latest small cap stock picks, be sure to consult Stock Pickers Digest.