Small cap stocks are companies that trade on the FTSE Small Caps index.

They tend to have a market capitalisation somewhere in the hundreds of millions of pounds; investors often view small caps as having stronger growth potential than the more mature companies quoted on the FTSE 100 or FTSE 250, but with correspondingly magnified risk.

Importantly, this can mean that their stock market performance can be more unpredictable. For context, the index has risen by 21% over the past five years, a positive result even if it has underperformed larger indices such as the S&P 500. But this broader performance hides the reality that in those five years, some individual companies have enjoyed exponential growth while others have flatlined or suffered sharp corrections.

Best small cap shares to watch

Here are some of the small cap shares we think may be worth watching. They have been selected for recent market news.

Always do your own research. Past performance is not a guide to future performance.

1. Halfords
2. Ricardo
3. Kier
4. Wickes
5. On the Beach

Halfords (LON:HFD)

Shares in Halfords are down 24% this year to 145.7p. The retailer, which sells motoring services and bike and car accessories from its chain of stores around the UK, has had a tough time in the past year. The company, which previously benefited from the boom in cycling, cut its profits forecast at the half-year results in November.

Sales of Halfords’ cycling products were hit by the cost of living crisis and customers have less cash in their pockets for discretionary spending. In its late February trading update, the company cut its profit guidance for the current financial year after seeing a 'further material weakening' in three of its four core markets, including cycling, retail motoring and consumer tyres.

Accordingly, the small cap business has seen a drop in like-for-like revenue growth, and now considers that profits for the year will be between £35 million and £40 million rather than the £48 million and £53 million it had previously advised.

For perspective, January volumes in the retail motoring market fell by 5.1% year-over-year, by 8% in cycling and by 4.3% in consumer tyres. In particular, the company argues that cycling has become more competitive, meaning promotions have had to increase while simultaneously more consumers are putting purchses on credit cards.

Halfords also noted that it forecast was based on conditions not improving for the rest of the year.

However, the shares trade on an undemanding price earnings ratio of 12 and the company enjoys a strong brand presence. This could make it a value play for long-term investors.

Ricardo (LON:RCDO)

Ricardo makes engines for Formula One McLaren cars and also has an environmental business. The shares are down 16% over the past 12 months to 485p. The company has been hit by a downturn in its automotive powertrain division and customer orders have been delayed.

As such, Ricardo saw pre-tax profits for the full year in March fall by 20% to £7.9 million (from £9.9 million in 2022).

Nevertheless, at the same time, the company also reported a record order book of £477 million, up 18% on a constant currency basis. Sales from its continuing operations increased by 8.8% to £224.2 million (from £212.7 million) as its energy and environment, rail and defense businesses also saw strong sales momentum.

The company says it is on track to meet market expectations for its full year results for the current financial year.

Kier Group (LON:KIE)

Contractor Kier Group has a construction business and also provides rail services. It was involved in the HS2 project and is likely to benefit from the Government’s need to fix the reinforced autoclaved aerated concrete plaguing many schools and public buildings around the UK.

The company posted strong interim results in March, with sales up 23% to £1.8 billion (£1.5 billion in 2022) boosted by growth in the infrastructure and construction division and pre-tax profits up 6% to £27 million (£25.4 million in 2022).

The order book rose by 6% to £10.7 billion (from £10.1 billion last year). Meanwhile, Kier has 97% of its revenue for the full year 2024 already in the bag – this excludes more long-term framework deals. In addition, the acquisition of Buckingham Group’s rail assets are now fully embedded into the business and performing better than expected.

The shares have had a great run over the past 12 months, rising 75% to 140.2p and are close to their five-year highs. Kier has reinstated the dividend this year, and arguably could be one of the prime beneficiaries if Labour wins the general election as the party tends to invest in infrastructure when in power.

Wickes (LON:WIX)

The home improvement retailer has been licking its wounds after feeling the effects of higher cost inflation. Indeed, half-year profits fell by 40% last year as a result. However, Wickes' recent full year figures were better than expected, with sales up 11% in its TradePro business and pre-tax profits up 2% to £41.1 million (from £40 million in 2022) boosted by cost savings. Revenues were flat at £1.6 billion (from £1.6 billion last year).

Wickes says it is seeing customers delay larger purchases, with orders in its design and installation business down, but sales in the second half of the year in its Wickes Lifestyle Kitchens business rose by 24% following a relaunch.

With the housing market sluggish, home owners are more likely to stay put and improve their existing homes, which is likely to benefit the DIY retailer in the longer term.

Meanwhile, the shares up 11% over the past 12 months at 143p, but are still some way off their three-year highs of 266p seen in May 2021. They trade on a reasonable price earnings ratio of 12 and offer a 7.6% dividend yield.

On the Beach (LON:OTB)

Holiday provider On the Beach continues to benefit from the uptick in customers booking holidays, despite the cost of living crisis. Winter bookings remain strong with the company beginning the New Year with a record forward order book, according to its recent AGM trading statement in January. According to the company, the total transaction value (TTV) of holidays sold was 27% up on the same period in 2023.

Then in May's interim results, the company issued a more comprehensive update. Total transaction value had rise by 22% year-over-year in the six months to 31 March, driving group adjusted EBITDA up some 93% to £8.1 million.

CEO Shaun Morton also highlighted 'the signing of our long-term distribution agreement with Ryanair was a milestone achievement in the period. Through this partnership, our customers can now secure free and fair access to Ryanair's seat supply, and we hope this industry-leading collaboration can be used as a blueprint for how the industry can better work together.'

The shares trade on a slightly elevated price earnings ratio of 16 but may be worth keeping an eye on.

How to invest or trade in small cap shares with us

1. Learn more about small cap shares

2. Open an account with us or practise on a demo

3. Select your opportunity

4. Choose your position size and manage your risk

5. Place your deal and monitor your trade

You can either invest in shares directly or trade using spread betting or CFDs to benefit from leverage.

Keep in mind, leverage means you can gain or lose money faster than expected. Because your position size is far greater than your deposit, you could lose more money than you put in. Be aware also that past performance is not an indicator of future returns.

Learn more about the differences between trading and investing here.

Top small cap shares to watch summed up

The above five companies are just a small selection of top stocks to watch among the small-capitalised companies. Remember that any company can also fail and always do your own research.

Trade and invest in over 17,000 UK, US and global shares from zero commission with us, the UK’s No.1 trading provider.* Learn more about trading or investing in shares with us, or open an account to get started today.

*Based on revenue excluding FX (published financial statements, October 2021).