Small cap stocks are companies with a “market cap” (the value of shares they have outstanding) below $2 billion, or some other arbitrary figure.

(In the latest Wall Street Stock Forecaster, we updated our buy/sell/hold advice on a former U.S. small cap stock that has jumped that’s 89.1% since we first recommended it in May 2007. At the time, the company’s market cap was $1.6 billion. But it has more than doubled since, to $3.4 billion today. See below for further details.)

Small cap stocks have the potential for strong gains, but they are generally more volatile than large-cap stocks. Temporary setbacks, such as a poor quarterly earnings report or the loss of a contract, can quickly cut their share prices. That’s why we view even the best small cap stocks as aggressive, and advise investors not to overindulge in small caps.

To cut your risk, we recommend looking for sound companies that stand to benefit as the economy continues to improve. It’s also important for these stocks to be well-established, with strong management and prominent positions in their industries.

High-quality small cap stocks often grow into large caps

We’ve first recommended Tupperware Brands Corp. (symbol TUP on New York) in the May 2007 Wall Street Stock Forecaster. The company is a good example of a small cap that has begun the transition to a large cap stock.

Tupperware makes high-quality products for the home, including plastic food and beverage containers and children’s educational toys. These products account for 70% of its revenue. The remaining 30% comes from its beauty products division, which makes a wide range of cosmetics, bath oils and fragrances.

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Unlike most consumer product makers, Tupperware prefers to sell its goods through independent dealers instead of stores. The company now has 2.5 million dealers in over 100 countries. These dealers hold “Tupperware parties” in homes, offices and other locations to demonstrate products and take orders.

In 2009, Tupperware’s dealers held 16.5 million parties worldwide. Using independent dealers instead of relying on retail-store staff helps keep Tupperware’s costs low. This approach also makes it easier to increase sales in less-developed countries with few stores or distribution networks.

Overseas expansion has huge potential—and risk

Tupperware reported record earnings of $40.8 million (before one-time items) in its latest quarter, mainly due to strong demand in fast-growing markets, such as India, Brazil, Indonesia and South Africa. Thanks to rising prosperity in these countries, more of their consumers can afford to buy food in bulk. That has spurred demand for Tupperware’s food containers.

Revenue rose 1.8%, to $523.2 million from $514.0 million. Without the impact of exchange rates, revenue would have risen 3%.

The U.S. dollar will likely stay high compared to other currencies, but not the Canadian dollar, for the next year or so. (Tupperware’s highest exposure is to the euro and Mexican peso.) The company offsets its currency risk with a hedging program. It also buys most of its raw materials in its local markets.

Besides volatile currencies, expanding in developing markets poses other risks. For example, in July 2010 the company uncovered accounting errors at its Russian subsidiary. The company has installed a new accounting system to prevent future errors.

As we mentioned, Tupperware has risen 89.3% since we first recommended it as one of our small cap picks in May 2007. In Wall Street Stock Forecaster, we look to see if it has the potential to go even higher.

You can get our full analysis, including clear buy/sell/hold advice, on Tupperware and 24 other U.S. stocks in the latest Wall Street Stock Forecaster. What’s more, you can get this issue absolutely free when you subscribe today. Click here to learn how.