The action in the market so far is inconclusive. The year started beautifully, then we plunged into another year showing losses. So soon.

For long-term investors who are buying companies with good prospects for several years to come, this is a buyers market. But there is one group to either avoid or treat with extreme care–small caps.

These stocks are doing much worse than large- and mid-cap stocks. As of Wednesday morning (Jan. 14), the large-cap Dow Industrials and the S&P 500 are down 3.7% and 3.5%. The S&P Midcaps are doing better– down 3%. But the Russell 2000 (small cap) Index is down 5% and the S&P small caps are down 6%.

Investors have the basic idea right. The smaller companies may not have the financial strength to weather the recession when customer spending dries up.

Certainly, some good small-cap companies will be winners, too. But I would avoid small-cap funds or any small company that I didn’t check very carefully. If you are interested in a company with a market capitalization under $2 billion take some basic precautions. Check that its debt is low and its profit margins are in the top half of its group, for starters.

Source: Where Not to Invest Yet