When it comes to market cap, size does matter.
Market cap is short for market capitalization. This is a metric that can give you helpful insight into the size and scale of the company offering a stock. Market cap sizes differ from company to company, and there are different advantages, disadvantages, and considerations that will come with these varying sizes.
So what is a market cap, how is it calculated, and why exactly does it matter? In this post, I’ll introduce you to the basics of market capitalization, including the difference between large-cap and small-cap stocks and how you can use this information to your advantage as a trader.
What Are the Market Capitalization Categories?
First, a few basics. Market capitalization is a term referring to the total value of a company’s outstanding stock shares.
To determine a company’s market cap, all you have to do is take the company’s total number of shares and multiply it by the current price per share.
So, if a company has 10 million shares and each share costs $2 each, its market cap would be $20 million.
Depending on what this calculation yields, a company might fall into any number of different categories, including:
As the name implies, large-cap companies are those with a higher market cap number.
Generally, a large-cap company is one that has a market cap of $10 billion to $100 billion, with massive companies of $200 billion or above sometimes being referred to as mega-cap companies.
These are the stalwarts and industry leaders, and they’ve usually been around for a good while. For example, a company like General Electric would be a good example of a large-cap company.
Mid-cap companies are smaller than large-cap companies, but still pretty big. They are companies that will fall between $2 billion and $10 billion using the market cap calculation.
These are established companies, but perhaps less likely than large-cap companies to be household names. They might still be growing, which means that while they’re not industry leaders now, they could be in the future.
An example of a mid-cap company is Helen of Troy, Inc, a home and health company that represents brands like PUR, Honeywell, Braun, and Vicks.
Small-cap companies are generally seen as those that have a market cap of $250 million to $2 billion.
These are companies that are on the smaller side, and might be new or emerging companies or within emerging sectors. For example, many of the emerging marijuana stocks in recent years would fall into this category.
Even smaller companies will be called nano or sometimes even micro-cap stocks, and these would include emerging companies and penny stocks.
Large-Cap vs. Small-Cap Historical Performance
One important difference between large and small-cap companies is the amount of historical data you might have access to. Here’s the lowdown:
Benefits of Large-Cap Stocks
Large-cap stocks are typically considered blue-chip stocks. This means that they’re stable, secure, and best of all in terms of fundamental research, they usually have plenty of historical data to look at.
These big companies didn’t get to where they are overnight, so you’ll often have years or even decades of data to look over which can help you figure out the future direction of the company based on its past.
Benefits of Small-Cap Stocks
Unfortunately, small-cap stocks aren’t as strong on the historical data front. Often, they are small because they are relatively new companies, or they might be within an up and coming sector. Or, they might be small-cap companies because they went public quickly to raise money.
Either way, small-cap companies typically don’t have a ton of financial history that is available for analysis.
So in terms of historical data, large-cap companies usually win out. While a big benefit of a small-cap company is that it can offer a potentially quick rate of return, it comes with higher risk because it’s more speculative.
Large-Cap vs. Small-Cap Mutual Funds
Mutual funds are an alternative to buying stock shares outright. Instead of representing a single security, they are composed of a basket of different stocks and securities.
Like stocks, mutual funds are available in different market cap sizes. So, a large-cap mutual fund would be composed of a variety of large-cap company stocks, and a small-cap mutual fund would be composed of a variety of small-cap company stocks.
A mutual fund can be a good alternative to buying stock shares outright because by having a position with a mutual fund, there is a built-in level of diversity that can help balance out the investment.
Investing in Large- vs. Small-Cap Stocks
Curious about some of the differences between investing in large versus small-cap stocks? Let’s review some of the important ones:
Advantages of Large-Cap Stocks
Large-cap stocks offer some distinct benefits. Since they are larger and more proven companies, the risk level tends to be lower. They’ve established themselves as industry leaders, so it’s unlikely that they’re going to crash and burn overnight. They typically offer the lure of slow but steady growth.
Drawbacks of Large-Cap Stocks
Since large-cap stocks have an inherently lower risk level, they tend to have a higher value. This means that they usually have a higher asking price and tend to have slower price movement, which means that they’re unlikely to deliver a very rapid return on your investment.
Advantages of Small-Cap Stocks
A lot of traders don’t want to wait years and years to grow their account, particularly if they’re new to the game. Small-cap stocks can be advantageous in this way.
Because they’re small, the share price is typically far lower than a large-cap company’s stock. And because they’re still working to establish themselves and growing, they can experience exponential growth, which means a potentially quicker and bigger return on your investment.
Drawbacks of Small-Cap Stocks
However, just because a small-cap company has the potential for growth doesn’t mean that it will grow. Many smaller companies will fail or flounder during their early years. This means that there’s a much higher level of risk associated with these stocks.
For instance, if a promising small biotech company has a drug that fails during the FDA approval process, the stock’s value could plummet overnight.
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Do you tend to trade large- or small-cap stocks? Leave a comment and tell me which type you prefer!