Did you know that microcap stocks make up half of all stocks listed on the U.S. stock exchanges? Probably not. That's because most aren't even covered by Wall Street analysts.

But these undiscovered stocks have a recent history of solid performance. For example, the Dow Jones Select Microcap Index has a 1-year annualized return of 15.2% as of March 31, 2006. It's 3-year track record is even more impressive with an annualized return of 17.3% in the same period. The 2,000 stocks in the Russell Microcap Index blew that performance away. It's 1-year annualized return is 26.5% as of March 31, 2006. The 3-year return is an impressive 31.6%.

Microcap stocks are publicly-traded companies with a market capitalization of less than $500 million. They are regarded as risky investments. However, they also provide some protection against declines in the Dow and S&P – their price movements are generally not tied to larger stocks. Therefore, microcap stocks can help diversify a portfolio.

There are also microcap ETFs, which can reduce the risk of holding just one or a couple of microcap stocks. After all, 1000 companies aren't likely to go out of business all at once. The three microcap ETFs on the market right now are iShares Russell Microcap, Powershares Zacks Micro Cap, and First Trust Dow Jones Select MicroCap.

From its name, you can probably guess that First Trust Dow Jones Select Microcap is based on the Dow Jones Select Microcap Index that we talked about above. The Dow Jones Select Microcap Index tracks the most liquid and fundamentally-strong microcaps that are traded on the New York Stock Exchange, the American Stock Exchange, and the Nasdaq. The composition of the index changes annually.

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The Powershares Zacks Micro Cap ETF is designed to mirror the performance of the Zacks Investment Research benchmark for microcap stocks. This ETF is more liquid, changing investments based on a weekly evaluation of the stocks' momentum and value.

The iShares Russell Microcap is based on the Russell Microcap Index, which tracks 1,000 of the smallest stocks in the Russell 2000 Index and the next 1000 smallest stocks. This index, like the Dow Jones, is reviewed annually for adjustments. The ETF screens the microcaps for liquidity, fundamentals, and other factors. The ETF owns about 1300 stocks.

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