Often a name itself holds the clue to the market capitalisation a company has. So, the terms big-cap and small-cap are self-explanatory as they indicate the value of the company in terms of its market capitalisation. Evidently, a big-cap or large-cap stock means that the company has a large market capitalisation. Similarly, small-cap stocks refer to a company with a smaller market capitalisation.
However, this classification has led to certain misconceptions such as you need tons of money to invest in large-cap stocks or that only large-cap stocks can give you decent profits. But the truth is that nowadays you can earn profits by investing in small-cap stocks too. Most investors don’t realise how profitable small-cap stocks have become and hence they miss several good investment opportunities.
Furthermore, big and small are relative terms as the definition of a small-cap stock has changed drastically over time. For instance, a large-cap stock of the 1980s might be a small-cap stock now because the definition of large-cap and small-cap has changed a lot over the years.
- Key Points to Note
- What is a Cap?
- Small-Cap Stocks
- Big-Cap Stocks
- How are the Caps Ranked?
- Changing Scenarios and Numbers
- How are the Small Caps Performing?
Key Points to Note
- Big-cap stocks have a market cap of $10 billion or more
- Small-cap stocks have a market cap of $300 million to $2 billion
- Small caps can outperform their large-cap peers
- Small-cap stocks make a good choice for a diversified portfolio
- Big-cap stocks don’t necessarily result in larger returns on investment
What is a Cap?
You must understand what exactly is meant by the word cap in the investment scenario. Cap is nothing but a short form of capitalisation. Although the word cap is independently used, it really stands for market capitalisation. That is when you use the word cap as in big cap; you are actually referring to the market cap or capitalisation. Technically, it refers to the ‘estimated total dollar value of a company’s outstanding shares in the market.’ This figure is arrived at by multiplying the stock’s price by the number of outstanding shares. In this context, you should remember to add the market value of the company’s publicly traded bonds to calculate its ‘total’ market value.
The market cap is relevant because it reveals the size of the company, a factor that most investors consider significant. It is important for them because the market cap reveals some of the key characteristics such as risk assessment of a company.
As mentioned elsewhere, terms like small and big are relative. Consequently, the value of a small-cap stock might slightly differ from broker to broker. However, the general consensus nowadays is that small-cap range between $300 million and $2 billion. A common misconception about the small caps is that they are start-ups or new companies that have just started its operation. Obviously, this is not true as several small-cap companies have a good track record and are incredibly successful, just like some of their large-cap counterparts. As the small-cap companies are smaller, their prices have greater growth potential, which means better prospects for the investor to earn some profits quickly.
Small-cap stocks trade on any exchange. However, the vast majority of them are found on NASDAQ and OTCBB as they have relatively fewer listing requirements. Some of the small-cap stocks traded on NASDAQ are Dynex Capital Inc., SiriusPoint Ltd., and Home Point Capital Inc.
Big cap stocks refer to the largest publicly traded companies with a market capitalisation of more than $10 billion. Some of the well-known big-cap companies are General Electric, IBM, 3M Co., McDonald’s corporation, Walt Disney, AT&T, Proctor and Gamble, and Walmart, among others. These big-cap companies are also commonly referred to as blue-chip stocks. The term blue-chip is used to refer to companies with a track record of dependable earnings, strong reputation, and robust financials, among others. However, although the blue-chip companies tend to perform well and offer a safe return for investors, it is not a good idea to use them as a representative of all large-cap stocks.
Similar to the small-cap stocks, there are several misconceptions in the case of large caps too. Some investors think that large-cap stocks carry lesser risk than smaller stocks because of their high value. However, that is not the case. Generally, the bigger the company, the harder they fall.
Let us consider the case of Enron to understand this. Enron was a favourite stock of the energy industry. But when an accounting scandal hit it, things turned upside down. The company used MTM accounting to show higher profits than it made. So, even when the company’s subsidiaries kept losing money, it continued to show profits using off balance-sheet entities so that the real picture was hidden. However, the deception could not be continued for long and the company had to file for bankruptcy in the end. Criminal charges were laid against the key people in management.
This episode was an eye-opener, and it shows that just because a company is a large-cap organisation it doesn’t always qualify as a great investment. There are several other factors you need to consider before investing in any of the stocks. Do your research thoroughly before you invest. Sometimes it makes sense to opt for smaller companies for better returns. In short, there is no guarantee that a large-cap stock will always give you great returns. If you are not careful, you might end up losing your investment.
How are the Caps Ranked?
The definitions of big cap and small-cap stocks have changed over time, and they still slightly differ from broker to broker. However, the differences between various brokerage definitions are largely superficial. In most cases, they don’t matter – the only case where they matter are for the companies that lie on the borderline. Such borderline companies must be classified correctly because the mutual funds apply these definitions to determine which stocks to buy. So, a large-cap company wrongly put in the small-cap company might not be noticed by mutual funds looking exclusively for large caps and vice versa.
For classification, the current approximate definitions are as under:
- Mega-cap – Companies such as Apple, Amazon, and Facebook with a market capitalization of $200 billion and higher.
- Big-cap – Companies such as Nvidia, J&J, and PayPal with a market capitalization of $10 billion and more
- Mid-cap – Companies such as Hewlett Packard Enterprise Co, Hyatt Hotels Corp, and Franklin Resources Inc, with a market capitalization between $2 billion and $10 billion
- Small-cap – Companies such as GameStop Corp., Cassava Sciences Inc, and Corsair Gaming Inc. with a $300 million to $2 billion market capitalization.
- Micro-cap – companies such as Magna Chip Semiconductor Corporation, Trebia Acquisition Corp., and Forterra Inc. with a market capitalization ranging from $50 million to $300 million
- Nano-cap – companies such as Ever-Glory Intl, Sigma Labs, and iFresh with a market capitalization below $50 million
You must remember that these categorisations are fluid and not fixed. They could change slightly depending on the brokers. As such, several circles regard stocks with a market capitalisation greater than $100 billion as mega caps. These categories have grown over time in conjunction with the market indexes. For instance, during the early 1980s, a company with a market cap of $1 billion or more was considered a big cap stock. But nowadays, such a company will be categorised as a small-cap.
Changing Scenarios and Numbers
Usually, it is the big cap stocks that get most of Wall Street's attention because that's where most of the lucrative investment banking businesses are concentrated. As large-cap stocks make up the majority of the equity market in the United States, they constitute the core of most of the investor portfolios.
Mega-cap stocks tend to shift in numbers. Hence, you will see that the numbers of mega stock companies change from time to time. While there were 17 of them in 2007, by 2010, there were less than five. In recent years, mega-cap stocks have made a comeback, mainly because of the technology giants such as Apple. At present, there are about a dozen mega-cap companies with a market capitalisation of over $300 billion trading in the US. Most of these companies are in the technology sector.
How are the Small Caps Performing?
As we mentioned earlier, just because they have a smaller market cap doesn't mean they don’t have value or offer great returns. You’ll find some small cap stocks to be more valuable as they enjoy some of the strongest track records, especially after the 1970s. When you take a closer look, you’ll also find that many of them outperform their large-cap contemporaries. This is because the large caps have matured over the years while the small caps are still growing.
Sometimes, the numbers and labels are meaningless. Labels such as small, big, mega, and the like may not indicate anything. This applies to the market capitalisation scenario too. Moreover, the various labels attached to the stock markets and indices can be confusing. For instance, the Dow Jones Industrial Average (DJIA) is regarded as containing only big-cap stocks whereas the NASDAQ is often considered the one that trades in the small-cap stocks. While these perceptions were largely true before the 1990s, they are no longer so. Times have changed and along with the tech boom, the market caps of most stock exchanges and indices are now varied and intersecting.
That is why relative terms such as small, big, and mega cannot be taken at their face value. They are often subjective and undergo regular changes. The most important thing to remember is that big does not always mean less risk or more profit. You need to bank on your research, experience as well as expert advice to make the correct investment decision. Don’t go by the market cap alone.
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