Finding a good small cap company is a difficult process as the coverage is limited.  To find good companies in this space that you like takes time and doing.  The divergence of performance is high in this part of the capitalization spectrum, that is, you have to shift through a 100 stocks to find one that you like.  The ratio of the ones you actually invest in is even smaller.  So once you find an investment aim to put in as much as possible because the absolute investment is small.  So if you buy a large stake at these prices, any positive surprise will pay big.  Here you are buying before any credible price discovery thereby leveraging the full appreciation of equity.  This end of the market is not efficient, so local information counts a lot – there is no substitute for going and kicking the tires.  The final return is highly dependent on this pre-discovery price.

      That does not mean that risk goes down substantially on whetting or that you are ascribing a greater than average acumen to your decision, what you are betting on is the portfolio dynamics.  Winners can theoretically go to infinity but losers can only go to zero.  So as long as you have done some due diligence and the product makes senses for a growing market, the odds are stacked in your favor! 

These investments are akin to buying naked calls, leverage comes pre-wrapped.  Using additional leverage individually might actually distort the return dynamic.  They also have all the other issues that plague consistent returns.  Management matters a lot.  You can’t/ won’t run the place, so make sure the guy running it knows what he is doing.  Accounting shenanigans and management’s on-the-job-consumption are a big no-no. 

To get a strong return, you have to hold on for the long term, if not you have to contend with reinvestment risk.  This is the reason investors like Peter Lynch and Warren Buffett never sell – you can never tell when the stock is likely to make its breakout move.  This is not easy.  It is like saying that you had to decide to make the investment anew everyday and you choose it every day!  A sell decision is contingent on whether the security continues to give good returns and just as importantly, what is your alternative avenue to park the funds.

Remember, the outside view – statistical historic average would work most times while your emotions will most likely lead you the wrong way.