Small Cap vs. Large Cap
Investors have to weigh a variety of characteristics when attempting to determine whether a potential investment is correct for them. Oftentimes, a company’s size is among the first qualities that come to mind. Maintaining a proper weighting of large-, medium-, and small-cap firms can make it easier to construct a portfolio that suits your specific risk tolerance.
Though important for stock pickers and mutual fund investors alike, trying to pinpoint where a specific company falls on the size spectrum can be challenging. Giants like Apple, Exxon Mobil, and General Electric are easy to pinpoint; their massive size and influence gives them easy entry into the large- and giant-cap classes. But what about other, less-obvious names? How does one determine what constitutes a small-cap?
Small-cap refers to a company’s market capitalization, which is computed by taking the number of outstanding shares and multiplying it by the share price. A company with 100,000 outstanding shares selling at $100 per share would then have a market capitalization of $10 million. That’s much too small to be a small-cap company, by the way.
Typically, a small-cap company is one whose capitalization is between $250 or $300 million and $2 billion. From $2 billion to $10 billion, a company is considered mid-cap. Above $10 billion is considered large-cap, many of which are equities considered blue chip stocks. In case you’re wondering, a company with a market capitalization between $50 million and $250 million is called a micro-cap, and below $50 million is called a nano-cap. And often a company with capitalization greater than $200 billion is called a mega-cap.
The appeal of small-cap stocks is their tremendous growth potential. Every big company started out small and the idea of finding the new Microsoft or Home Depot appeals to many investors. A company with a market capitalization of $500 million is capable of doubling in size in a fairly short period of time to a capitalization of $1 billion. If profits rise as well, investors will undoubtedly be rewarded with a hefty gain in stock price. But a large-cap company whose capitalization is $100 billion is not going to double in size anytime soon. They will see slower, incremental growth, and their stock price will reflect that
The downside of small-cap stocks is that they present much higher potential risk. A small company that has problems with just one of its major products can find itself suddenly losing money, or at least disappointing investors and watching its stock price plunge. Big blue chip stocks are much more resistant to broad shifts in stock price.
We promote diversification in our portfolios, but investors need to monitor expectations when determining where to place their funds. There is no need to evenly weight exposure across the market capitalization spectrum. Rather, investors anticipating choppiness up ahead should be drawn to the stability and value that larger companies represent.
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