The meanings of big cap and small cap are generally understood by their names. Big cap stocks—also referred to as large cap stocks—are shares of larger companies. Small cap stocks, on the other hand, are shares of smaller companies. Labels like these can often be misleading because many people run under the assumption that they can only make money by investing in large cap stocks. And that can't be further from the truth—especially nowadays. If you don't realize how big small cap stocks have become, you'll miss some good investment opportunities.
Small cap stocks are considered good investments due to their low valuations and potential to grow into big cap stocks, but the definition of a small cap has changed over time. What was considered a big cap stock in 1980 is now a small cap stock today. This article will define the caps and provide additional information to help investors understand terms that are often taken for granted.
- Small cap stocks shouldn't be overlooked when putting together a diverse portfolio.
- Big cap stocks don’t always mean larger returns on investment.
- Small cap stocks generally have a market cap of $300 million to $2 billion, and have been known to outperform their large cap peers.
Scaling Up Stocks
Before we do anything else, we first need to define the word cap—which is short for capitalization. The term in its entirety, though, is market capitalization or market cap. This is the market's estimate of the total dollar value of a company's outstanding shares. To get this figure, you need to multiply the price of a stock by the number of shares outstanding. One thing to keep in mind, though, is that while this is the common conception of market capitalization, you actually need to add the market value of any of the company's publicly-traded bonds to calculate the total market value of a company.
The market cap shows the size of the company, something of interest to most investors. That's because it generally points out several key characteristics of a company including its risk assessment. Although the value of small cap stocks may vary from broker to broker, the general consensus today is that they have market caps ranging from $300 million to $2 billion.
One misconception people have about small caps is that they are startup companies or are just brand new entities that are breaking out. But this can't be further from the truth. Many of small cap companies are just like their larger counterparts in that they have strong track records, are well-established, and have great financials. And because they are smaller, small cap share prices have a greater chance of growth. This means they have much more potential for investors to earn money faster.
Understanding Small vs. Big-Cap Stocks
The Big Boys
Big cap stocks refer to the largest publicly-traded companies with market caps of more than $10 billion like General Electric and Walmart. These companies are also called blue chip stocks—companies with a history of dependable earnings, solid reputations, and strong financials. While companies like these tend to perform well and provide safe returns for investors, you can't use this as a blanket for all large caps. Some investors have the misconception that the large cap market comes with much less risk than other, smaller stocks because of their value. There have been several cases in financial history that point to the opposite—Enron is just one example. It serves to demonstrate that the bigger they are, the harder they fall.
The company, which was a darling of the energy industry, was the subject of an accounting scandal. The company used mark to market (MTM) accounting to make the company look like it was much more profitable than it actually was. Its subsidiaries were losing money, but the company continued to hide its losses and debt, using off-balance-sheet entities to mask toxic assets. The company buckled, and ended up filing for bankruptcy. Key personnel, including CEO Jeffrey Skilling and the company's accounting firm faced criminal charges.
The lesson? Just because it's a large cap, doesn't mean it's always a great investment. You still have to do your research, which means looking at other, smaller companies which can provide you with a great basis for your overall investment portfolio.
Dow vs. Nasdaq: The average market cap for the Dow remains much larger than the average market cap for the Nasdaq 100.
The definitions of big or large cap, and small cap stocks differ slightly between brokerage companies and have changed over time. The differences between the brokerage definitions are relatively superficial and only matter for the companies that lie on the edges. The classification is important for borderline companies because mutual funds use these definitions to determine which stocks to buy.
The current approximate definitions are as follows:
- Mega Cap: Market cap of $200 billion and greater
- Big Cap: $10 billion and greater
- Mid Cap: $2 billion to $10 billion
- Small Cap: $300 million to $2 billion
- Micro Cap: $50 million to $300 million
- Nano Cap: Under $50 million
These categories have increased over time along with the market indexes. And it is important to note that these definitions are fluid and not fixed. For example, in several circles, stocks with market caps greater than $100 billion are seen as mega caps. In the early 1980s, a big cap stock had a market cap of $1 billion. Today, that size is viewed as small. It remains to be seen if these definitions also deflate when the market does.
The big cap stocks get most of Wall Street's attention because that's where you'll find the lucrative investment banking business. Large cap stocks make up the majority of the equity market in the United States, which is why they make up the nucleus of many investors' portfolios.
Mega cap stocks, on the other hand, tend to shift in numbers. There were 17 of these stocks in existence in 2007, but that number shrunk to less than five by 2010 due to the 2008 mortgage meltdown and the Great Recession. In 2017 and 2018, mega cap stocks have made a resurgence and behemoths such as Apple (AAPL) have reached historic market cap highs. The total number of mega cap stocks in existence are not available yet for 2019.
But what about small caps? Remember, just because they have a smaller market cap doesn't mean you won't find value or great returns. In fact, much of the value in the stock market can be found through small cap stocks because they have some of the strongest track records around. Many of them also tend to outperform their large cap peers.
The Bottom Line
The big and small labels are also attached to the major stock exchanges and indexes, which also leads to confusion. The Dow Jones Industrial Average (DJIA) is viewed as consisting of only big-cap stocks while the Nasdaq is often viewed as being comprised of small cap stocks. These perceptions were generally true before 1990, but have since changed. Since the tech boom, the market caps of the stock exchanges and indexes vary and overlap.
Labels such as big and small are subjective, relative and change over time. Big does not always mean less risky, but the big caps are the stocks most closely followed by Wall Street analysts. This attention, however, generally means that there are no value plays in the big-cap arena.