Small cap is a term used to classify companies with a relatively small market capitalization. A company's market capitalization is the market value of its outstanding shares. The definition of small cap can vary among brokerages, but it is generally a company with a market capitalization of between $300 million and $2 billion.
To calculate a company's market capitalization, multiply its current share price by its number of outstanding shares. For example, as of June 2016, Sonic Corp., which owns the Sonic Drive-In chain, has 48.55 million shares outstanding and a share price of $28.16. Therefore, its market capitalization is approximately $1.37 billion. Because this figure is under $2 billion, most brokerages consider Sonic Corp. a small-cap company as of 2016.
As a general rule, small-cap companies offer investors more room for growth but also confer greater risk and volatility than large-cap companies, which have market capitalization of $10 billion or greater. With large-cap companies, such as General Electric and Boeing, the most aggressive growth tends to be in the rear-view mirror, and as a result, such companies offer investors stability more than big returns that crush the market.
Historically, small-cap stocks have outperformed large-cap stocks. Having said that, whether smaller or larger companies perform better varies over time based on the broader economic climate. For example, large-cap companies dominated during the tech bubble of the 1990s, as investors gravitated toward large-cap tech stocks such as Microsoft, Cisco and AOL Time Warner. After the bubble burst in March 2000, small-cap companies became the better performers until 2002, as many of the large-caps that had enjoyed immense success during the 1990s hemorrhaged value amid the crash.
Investors wanting the best of both worlds might consider mid-cap companies, which have market capitalizations between $2 billion and $10 billion. Historically, these companies have offered more stability than small-cap companies yet confer more growth potential than large-cap companies.