Small cap equities. Most people have heard about them and some have even ventured into them for investment purposes. The one thing many people might have noticed over the past couple of years is that small cap equities can be highly volatile whenever the economic conditions are questionable. (In reality, a lot of medium-cap equities became small-cap thanks to the devaluation of equities over the past two years or so).

Evidently small capitalization stocks are a little more sensitive to uncertainty in the economy. But what made them a little more sensitive during the credit crisis was that the credit taps were essentially turned off. This made it difficult for a lot of companies to obtain new credit or renew existing facilities. In instances where credit was renewed, financial covenants became more restrictive, forcing the companies to evaluate whether to maintain access to capital or to let go of the credit facility altogether. In cases where they had no choice, future expansion programs were turfed and they were left having to survive with whatever equity and cash they had on hand. Understandably, this became difficult and many small capitalization companies ended up going away.

However, the viable small cap companies that found their stock pummelled by the markets were faced with a rare opportunity; they could buy back their stock on the open market at discount prices. This is what many small cap companies did, allowing them to increase their treasury supply of shares so that, when equity markets regain strength, they can either leverage themselves against equity or acquire firms who are not as fiscally strong. Small cap companies that were able to execute on share-repurchase plans are telling stock investors two things:

1. Their stock is undervalued. This may be based on a number of objective financial measurements, such as price/book, price/sales and so on.

2. They have the ability to repurchase shares (meaning they have cash in the bank) and have long term plans for growth, which they will fund with their equity. This is a great tip for investors, particularly small cap investors.

So, are small cap stocks right for you? Well, this type of stock is not appropriate for all investors. In many cases, small cap shares are meant to be held for a longer-term, usually five years or longer. This longer-term horizon allows the companies to mature, sometimes increasing their capitalization and moving into the medium cap range (or even beyond in some cases, and companies like Research In Motion come to mind).

In addition to the time horizon, investors should have the risk tolerance to invest in such securities. Since there is more financial pressure on small caps, there is a good chance that they can disappear, particularly if the underlying companies have shrunk from large or medium cap shares to small. Companies that come to mind are Nortel Networks, General Motors, and so on.

For investors with the right risk tolerance and appreciation for the minimum time period will do fine with this segment of the investment world. However, entering into such an investment blindly will only result in frustration and, ultimately, failure.