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 a recent Wall Street Stock Forecaster, we updated our buy/sell/hold advice on a U.S. small cap stock that’s up nearly 63% since March 2009. 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-caps 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.

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Diverse operations help cut this small cap stock’s risk

We’ve covered Genuine Parts Co. (symbol GPC on New York) in Wall Street Stock Forecaster for some time. The company distributes replacement automotive parts to over 4,800 independent stores in North America. It also owns and operates over 1,100 auto-parts stores under the NAPA banner.

Genuine has built up its other businesses to cut its reliance on the struggling automotive industry. It now gets half of its revenue from distributing industrial parts, office supplies and electrical equipment.

That’s good for Genuine’s long-term prospects, because demand for these products should rise as the economy rebounds. Meanwhile, demand for replacement auto parts should remain strong as more people hang on to their older cars instead of buying new ones.

The company has taken advantage of the weak economy to make acquisitions: It spent $60 million buying other related firms in 2009. It also paid $63 million for full control of an auto-parts subsidiary.

Growing by acquisition adds risk. But Genuine Parts’ balance sheet is strong, so it can easily afford these purchases. Its debt is low, and it holds cash of $363.1 million, or $2.28 a share.

To get our latest buy/sell/hold advice on Genuine Parts and dozens of other small and large-cap U.S. stocks, you should subscribe to Wall Street Stock Forecaster. Click here to learn how you can get a one month free trial.