What Is a Small-Cap?

A small-cap is a public company whose total market value, or market capitalization, is about $300 million to $2 billion. The precise figures vary.

Small-cap investors generally are looking for up-and-coming young companies that are growing fast. That is, they're looking for the large caps of the future.

Key Takeaways

  • A small-cap is generally a company with a market capitalization of between $300 million and $2 billion.
  • Small-cap investors seek to beat institutional investors by focusing on growth opportunities.
  • Small-cap stocks historically have outperformed large-cap stocks but are also more volatile and riskier.
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Small Cap Stock

Understanding Small-Cap

The "cap" in small-cap stands for capitalization. The term in its entirety is market capitalization.

This is the market's current estimate of the total dollar value of a company's outstanding shares. To calculate a company's market capitalization, multiply its current share price by the number of outstanding shares.

Classifications such as large-cap or small-cap are approximations that change over time. Furthermore, the precise definition of small-cap stocks vs. large-cap stocks may vary among brokers.

One misconception about small caps is that they are startups or brand new companies. In reality, many small-cap companies are well-established businesses with strong track records and great financials. And because they are smaller, small-cap share prices have a greater chance of growth.

Investing in Small-Cap vs. Large-Cap Companies

As a rule, small-cap companies offer investors more room for growth but also bring greater risk and volatility than large-cap companies.

A large-cap offering has a market capitalization of $10 billion or higher. For large-cap companies such as General Electric (GE) and Coca-Cola Co. (KO), aggressive growth may be in the rear-view mirror. Such companies offer investors stability and dividends but rarely fast growth.

Historically, small-cap stocks have outperformed large-cap stocks. That said, 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 stocks such as Microsoft (MSFT), Cisco (CSCO), and AOL Time Warner. After the bubble burst in March 2000, small-cap companies became the better performers, as many of the large caps hemorrhaged value in the crash.

One advantage of investing in small-cap stocks is the opportunity to beat institutional investors. Many mutual funds have internal rules that restrict them from buying small-cap companies. In addition, the Investment Company Act of 1940 prohibits mutual funds from owning more than 10% of a company's voting stock. This makes it difficult for mutual funds to build a meaningful position in small-cap stocks.

A stock smaller than a small-cap is known as a micro-cap. That is a publicly traded company with a market capitalization of about $50 million to $300 million.

Small-Cap vs. Midcap

Investors who want the best of both worlds might consider midcap companies, which have market capitalizations between $2 billion and $10 billion. Historically, these companies can offer more stability than small-cap companies yet confer more growth potential than large-cap companies.

However, for self-directed investors, spending the time to sift through small caps to find a diamond in the rough can prove to be time well spent. Even in our data-rich world, great small-cap investments fly under investor radar because they get little coverage from analysts.

Small-Cap Stocks and the Russell 2000

The Russell 2000 is a small-cap stock market index composed of the 2000 smallest companies in the Russell 3000. The index is frequently used as a benchmark for measuring the performance of small-cap mutual funds.

The S&P and Dow Jones indices focus on large-cap stocks.

Thus, investors hoping to track small-cap stocks' performance should keep their eyes glued to the Russell 2000 or the S&P600—a similar small-cap index.