Small Cap Stocks vs. Large Cap Stocks: An Overview

Historically, market capitalization, defined as the value of all outstanding shares of a corporation, has an inverse or opposite relationship to both risk and return. On average, large-cap corporations—those with market capitalizations of US$10 billion and greater—tend to grow more slowly than mid-cap companies. Mid-cap companies are those with capitalization between $2 and $10 billion, while small-cap corporations have between $300 million and $2 billion. These definitions of large cap and small cap differ slightly between the brokerage houses, and the dividing lines have shifted over time. The differing definitions are relatively superficial and only matter for the companies that are on the borderlines.

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Understanding Small vs. Big-Cap Stocks

Small Cap Stocks

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

Smaller businesses will float smaller offerings of shares. So, these stocks may be thinly traded and it may take longer for their transactions to finalize. However, the small-cap marketplace is one place where the individual investor has an advantage over institutional investors. Since they buy large blocks of stocks, institutional investors do not involve themselves as frequently in small-cap offerings. If they did, they would find themselves owning controlling portions of these smaller businesses.

Lack of liquidity remains a struggle for small-cap stocks, especially for investors who take pride in building their portfolios on diversification. This difference has two effects:

  1. Small cap investors may struggle to offload shares. When there is less liquidity in a marketplace, an investor may find it takes longer to buy or sell a particular holding with little daily trading volume.
  2. The managers of small-cap funds close their funds to new investors at lower assets under management (AUM) thresholds.

Volatility struck small caps in late 2018, although this is not a new phenomenon. Small cap stocks did well in the first three quarters of 2018, entering September of that year with the Russell 2000 index up 13.4% compared to 8.5% for the S&P 500. Between 1980 and 2015, small caps averaged 11.24% annual growth in the face of rising interest rates, easily outpacing midcaps at 8.59% and large caps at 8.00%. In the first weeks of 2019, the Russell 2000 led the market by 7% to the S&P 500’s 3.7%.

Lack of liquidity remains a struggle for small caps, especially for investors who take pride in building their portfolios on diversification.

Large Cap Stocks

Large-cap stocks—also known as big caps—are shares that trade for corporations with a market capitalization of $10 billion or more. Large-cap stocks tend to be less volatile during rough markets as investors fly to quality and stability and become more risk-averse. These companies comprise over 90% of the American equities marketplace 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 indices and benchmarks follow large-cap companies such as the Dow Jones Industrial Average (DJIA) and the Standard and Poor's 500 (S&P 500).

Key Differences

There is a decided 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 financials, independent research, and market data available for investors to review. Additionally, large caps tend to operate with more market efficiency—trading at prices that reflect the underlying company—also, they trade at higher volumes than their smaller cousins.

Despite its struggles, the earnings growth for the S&P 500 remains positive for the first quarter of 2019, with earnings outlooks for the end of the year totaling $154.67 per share. In early 2019, the S&P 500 experienced a breadth thrust—a market momentum indicator—in which more than 85% of the NYSE stocks advance within two-weeks.

This momentum phenomenon historically signals an upswing in the market. In 1987, 2009, 2011, and 2016, it represented a prime buying opportunity for short-hold investors wishing to realize short term gains. However, in 2008, the breadth thrust was followed by a steep decline in the market some months after its occurrence in late March. Nevertheless, there are reasons to be optimistic when it comes to large caps.

It would be more precise to say there are reasons to be optimistic with large caps relative to other domestic stock sizes. Small caps are more affordable than large caps, but volatility in these markets points to large-cap leadership in 2019.

What is perhaps most encouraging is the fact that large technology companies cemented their status as valuation and earnings champions, even as domestic markets plodded. As investors look for comfort and quality in 2019, expect large caps to receive an even larger share of attention than usual.

Key Takeaways

  • Large-cap corporations, or those with larger market capitalizations of $10 billion or more, tend to grow more slowly than small caps between $250 million and $2 billion.
  • Large caps tend to be less volatile during rough markets as investors fly to quality and become more risk-averse.
  • Small caps and midcaps are more affordable than large caps, but volatility in these markets points to large-cap leadership in 2019.