You might have heard the term ‘small-cap’ or ‘big cap’ stocks before. It refers to the value, as the name suggests, of the stock when considering market capitalization. Small-cap stocks are stocks of smaller companies in the market while big-cap stocks are those of companies with more market capitalization. (1)Financial Industry Regulatory Authority."Market Cap, Explained."
As a newcomer to online trading, the impression is usually that it’s best to invest in big-cap stocks in order to make a profit. However, this isn’t the case in any sense, and small-cap stocks, actually have terrific investment potential.
The reason for this is that small-cap stocks have lower valuations in relation to big-cap stocks but also possess the opportunity to grow into the latter. Interestingly, definition of a small-cap stock in dollar terms has changed considerably over the years. What was once deemed a big-cap stock in the past will now be considered a small-cap stock. Let’s look at this in closer detail.
Small-cap stocks are not only smaller in terms of market capitalization but the respective companies also have less reach and sway within the market. The total market cap of these companies is much lower at a quarter of a billion dollars to $2 billion at most. Furthermore, you’ll find small-cap stocks are associated with companies across sectors.
In order to have a better idea about small-cap stocks, you need to understand that these aren’t all new or emerging companies. A large percetaneg of small-cap stocks have been around for a considerable amount of time. Inherently, these entities have produced steady financials and, due to the nature of their size, possess the potential to grow exponentially.
Comparing performance: Given past data, many small-cap stocks have performed better than big-cap stocks but there are a number of factors to consider. Over a longer period of time, and considering the inevitable downswings in the economny at certain points, big-cap stocks tend to fare better. (2)Allen, Gregory C."The Active Management Premium in Small-Cap U.S. Equities: Abstract."
Another vital aspect of small-cap stocks is the underlying volatility that is less pronounced when assessing big-cap stocks. The nature of these smaller stocks means that daily events will trigger bigger price movements, even if less trading volume taking place. For many risk-averse traders, this is enough to deter investments in small-cap stocks but those who engage in day trading, for instance, are able to capitlize on the volatility and depend on it on many occasions. However, there is also less liquidity with small-cap stocks, it’s also difficult at times to execute a trade successfully.
As you will have noted by now, big-cap stocks include companies with massive market capitalization which exceed $10 billion. Also referred to as blue-chip companies, the likes of Apple and Amazon have incredible track records in terms of financial solvency and performance while also having a transparent outward appearance. For the most part, investing in big-cap stocks provides you with reliable returns on investment over time but it isn’t to say that it’s a foolproof way of securing profits.
These companies have a solid foundation in place and are as dependable in the business world as one could hope for. However, certain companies that have long been considered as a reliable source for wealth generation, have fallen by the wayside and left investors without much to show for their initial faith. One can simply read past financial news to realize that this has occurred on many an occasion.
For instance, Lehman Brothers – once a pioneer in investment banking – came a part at the seams during the financial crisis of ‘08 and filed for bankruptcy. Through masking over shaky financials and being hit incredibly hard during the subprime mortgage crisis, the company had no other choice but to liquid any remaining assets. What was once a big-cap company with a steady share price, and regular returns and dividends for investors, led to extreme market volatility and big losses for shareholders.
Thus, it’s clear that you need to do your due diligence and understand that investing in a well-known company with big-cap stocks doesn’t always relate to a profitable investment. Make sure you keep your finger on the pulse and keep the door open for small-cap stocks that will diverify your portfolio.
The Indexes That Keep Track of Big-Cap Stocks
Many of you will be looking to invest in big-cap stocks. If so, then you can keep a watchful eye on ETFs and index funds which are tracked by Dow Jones which includes 30 big-cap stocks or the S&P 500 which includes the 500 biggest companies in the US.
The Indexes That Keep Track of Small-Cap Stocks
There are other indexes which track small-cap stocks such as the S&P Small-Cap 600 or the Russell 2000 Index. These two will provide you with ample info and opportunity to invest in small-cap stocks with great potential.
How Market Capitalization is Ranked
When assessing the definition of small-cap and big-cap stocks, it tends to vary from one online broker and trading platform to the next. However, these rankings don’t matter for the most part except when considering stocks that lie on the periphery. This is because mutual funds use these definitions to analyze which stocks to invest in. Below, we have listed the market cap of different market cap values.
- Big-cap: $10 billion and upwards up until $200 billion
- Mid-cap: $2 billion – $10 billion
- Small-cap: $250 million – $2 billion
- Micro-cap: $50 million – $250 million
The valuation of these different caps has certainly increased over time. These definitions aren’t balck and white but rather change dynamically and is up for interpretation given relevant investment circles.
Investing in Stocks – Big-Cap or Small-Cap?
Getting to know which stocks are better to invest in depends on the type of investor that you are. For those who are less risk-averse and aren’t looking to make short-term gains, then small-cap stocks are great because of rapid growth and higher performance over time. However, if you wish to have peace of mind with stable apprecation and income in the form of dividends, then big-cap stocks are more suitable. Finally, diversiyfing your portfolio and managing risk is best done by investing in a variety of stocks; both small-cap and big-cap in nature.
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