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Small Cap Stocks vs. Large Cap: Key Differences

Small Cap Stocks vs. Large Cap Stocks: An Overview

Historically, market capitalization, defined as the value of all outstanding shares of a company, has an inverse or opposite relationship to both risk and return. On average, large-cap companies, those with a market capitalization of US$10 billion and above, tend to grow more slowly than mid-cap companies. Mid-cap companies are those with a capitalization between $2 billion and $10 billion, while small-cap companies have between $300 million and $2 billion.

These definitions of large cap and small cap differ slightly between brokerages and the lines of demarcation have shifted over time. The different definitions are relatively superficial and only matter to companies that are at the frontier.

Key points to remember

  • Publicly listed companies are often segmented based on their market capitalization, which is the total market value of their shares.
  • Large-cap companies, or those with a market capitalization of $10 billion or more, tend to grow more slowly than small-cap companies, which are worth between $300 million and $2 billion.
  • Large caps tend to be more mature companies and are therefore less volatile when markets are tough as investors turn to quality and become more risk averse.
  • Small and mid cap stocks may be more affordable to investors than large caps, but small stocks also tend to have greater price volatility.

Understanding small and large caps

Small cap stocks

Small cap stocks have fewer publicly traded stocks than mid or large cap businesses. As mentioned earlier, these companies hold between $300 million and $2 billion of the total value of all outstanding shares, those held by investors, institutional investors and company insiders.

Smaller companies will launch smaller stock offerings. Thus, these stocks may be thinly traded and it may take longer for them to complete transactions. However, the small cap market is one place where the individual investor has an advantage over institutional investors. Because they buy large blocks of stocks, institutional investors don’t get involved in small-cap offerings as frequently. If they did, they would end up owning majority shares of these small companies.

The lack of liquidity remains a fight for small cap stocks, especially for investors who pride themselves on building their portfolios on diversification. This difference has two effects:

  1. Small cap investors may find it difficult to get rid of stocks. When there is less liquidity in a market, an investor may find that it takes longer to buy or sell a particular asset with low daily trading volume.
  2. Small cap fund managers are closing their funds to new investors at assets under management (AUM) thresholds.

Lack of liquidity remains a problem for small caps, especially for investors who pride themselves on building their portfolios on diversification.

Large Cap Stocks

Large Cap Stocks– also known as large caps – are stocks that trade for companies with a market capitalization of $10 billion or more. Large cap stocks tend to be less volatile during tough markets as investors turn to quality and stability and become more risk averse.

These companies account for more than 90% of the US stock market and include names such as mobile communications giant Apple (AAPL), multinational conglomerate Berkshire Hathaway (BRK.A) and oil and gas colossus Exxon Mobil (XOM). Many indexes and benchmarks track large cap companies such as the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 (S&P 500).

Since large-cap stocks make up the majority of the US stock market, they are often considered basic portfolio investments. Characteristics often associated with large cap stocks include the following:

  1. Transparent: Large-cap companies are generally transparent, making it easy for investors to find and analyze public information about them.
  2. Dividend Payers: Large-cap, stable, established companies are often the companies investors choose for dividend income distributions. Their establishment in a mature market has allowed them to establish and commit to high dividend payout ratios.
  3. Stable and impactful: Large-cap stocks are typically blue-chip companies in the peak phase of the business cycle, generating established and stable revenue and earnings. They tend to evolve with the market economy due to their size. They are also market leaders. They produce innovative solutions often with operations in the global market, and market news about these companies usually impacts the entire market.

Main differences

There is a clear advantage for large caps in terms of liquidity and research coverage. Large cap offerings have a strong following and there is an abundance of company financial data, independent research and market data available to investors. Additionally, large caps tend to operate with greater market efficiency – trading at prices that reflect the underlying company – they also trade at higher volumes than their smaller cousins.

Small cap stocks tend to be more volatile and riskier investments. Small-cap companies generally have less access to capital and, overall, not as many financial resources. It is therefore difficult for small businesses to obtain the necessary resources funding to fill the gaps in cash flowfinance new market growth activities or undertake large capital expenditures. This problem can be compounded for small cap companies during troughs in the economic cycle.

Despite the added risk of small cap stocks, there are good arguments for investing in them. One of the advantages is that it is easier for small businesses to generate commensurately high growth rates. Sales of $500,000 can be doubled much more easily than sales of $5 million. Also, since a small, intimate management staff often runs small businesses, they can adapt more quickly to changing market conditions, much in the same way that it is easier for a small boat to change of course than for a large liner.

Similarly, large-cap stocks aren’t always ideal. As mature businesses, they may offer fewer opportunities for growth and may not be as nimble to changing economic trends. Indeed, several large companies have experienced turbulence and lost favor. Just because it’s a large cap doesn’t mean it’s always a great investment. You still need to do your research, which means researching other smaller companies that can provide you with a great base for your overall investment. wallet.

Historical example

Volatility hit small caps at the end of 2018, although this is not a new phenomenon. Small-cap stocks performed well in the first three quarters of 2018, entering September of that year with the Russell 2000 Index up 13.4% versus 8.5% for the S&P 500.  Between 1980 and 2015, small caps grew by an average annual of 11.24% in the face of rising interest rates, easily outpacing mid caps at 8.59% and large caps at 8.00%.In the first weeks of 2019, the Russell 2000 led the market 7% to 3.7% for the S&P 500. 

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