What to Look for in Micro-Cap ETFs | ETF Trends

Does the bond market seem too conventional? Trying to find that next big thing? Well, micro-caps and their related exchange traded funds (ETFs) have some potential upside, but investors be warned: the small size of micro-caps makes them a bit risky.

Finding that gem in the rough may some doing some homework, but Tim Hanson for Motley Fool shares some of his tips for making the search easier.

  • Think Small. Start with the small companies. Firms with less than a $250 million market cap will do.
  • Business Model. Next, pick out micro-caps that have a strong business, which includes a strong balance sheet, has some extra cash on hand for some extra wiggle room and is free cash-flow positive.
  • Value. Price-to-Earnings is a good indicator, but Enterprise Value-to-EBITDA can also be useful. Anything less than seven is a good sign.
  • Shareholder-Friendly. Identify if the company is an insider ownership and whether the company pays dividends. Micro-caps heavily invested by managers and pay out dividends tend to be more in tune with outside investors.

Of course, one could forgo all the grunt work involved in picking individual stocks and invest in an all-encompassing ETF. In addition to saving you much time and effort on research, ETFs also help reduce the overall risk of owning individual stock investments. [Micro-Cap ETFs: Higher Risk, But Higher Reward?]

To find the right ETF for you, things to consider would be: assets, trading volume, composition and distribution of the holdings. You can find all of this information on the ETF Resume.

  • iShares Russell Micro-cap Index ETF (NYSEArca: IWC): Heaviest weighted in financials, at 24.2%. Other major sectors include health care, technology, consumer discretionary and industrials. IWC is the largest of the micro-cap ETFs, and it’s up 5.3% year-to-date.
  • PowerShares Zacks Mico-cap ETF (NYSEArca: PZI): PZI also has a high weighting in financials, which are about 25% of the fund. Consumer discretionary and technology are also large sectors in the fund. It’s up 1.2% year-to-date.
  • First Trust Dow Jones Micro-cap ETF (NYSEArca: FDM): Financials is the largest sector, but it’s weighted slightly less than both IWC and PZI at 18.7%. Consumer discretionary, industrials and consumer staples are also well-represented. It’s up 3.2% year-to-date.

For more information on micro-caps, visit our micro-cap category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.