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How stock type size affects your investment decisions

How stock type size affects your investment decisions

Beginner

1st September, 10:14
Updated: 23rd September, 07:20

Another way to differentiate stocks from each other is by the size of their market capitalisation.

Every publicly-traded company has a market capitalisation, and this refers to the total value of the company’s outstanding stocks. The size of the market cap you prefer in a stock will say a lot about your preferred approach to investing, so let’s take a look at what you want to consider.

What are the different sizes of market capitalisation when it comes to stock?

Typically, stocks are grouped into three classes of market cap size: small-cap, mid-cap, and large-cap. Small-cap stocks are those with market capitalisations of $2 billion or lower; mid-cap stocks are those with market caps of $2 billion to $10 billion; and large-cap stocks are those with market caps greater than $10 billion. 

Why do investors base the stock types they choose on a stock’s market capitalisation?

Because in this case, size definitely matters. Small-cap stocks tend to offer the biggest potential return, but also higher volatility. Large-cap stocks leave you with less volatility, but also tend to be slower-moving in terms of growth over time. Mid-cap stocks are essentially a happy medium between the two extremes. So you’ll want to figure out your tolerance for volatility as well as your goals when it comes to the size of your potential gains before choosing a stock from one of these three market cap categories.

What are the defining characteristics of each different market cap size?

1) Small-Cap Stocks

If you think about all of the well-known powerhouse stocks of today, many of them started off as small-cap (market cap of $2 billion or lower) companies with big dreams. Small-cap stocks are typically companies that are still at the beginning stages of their fundamental growth. Since accelerating earnings growth is the driving force behind big stock gains, these beginning stages mark a chance for investors to get in on the ground floor and tap into these companies’ potential before the rest of the world figures it out. 

One more thing: Generally speaking, the higher a stock’s average daily trading volume, the less volatile its price movements will be, since it takes a tidal wave of trading to truly move the needle. Since small-cap stocks tend to trade on lighter volume than their larger-cap peers, they’re naturally more volatile as a result. Volatility when the markets move in your favour is a good thing, since it can lead to big gains quickly. But volatility can also mean that when the market takes a downturn, small-cap stocks are hit hard.

2) Mid-Cap Stocks

With a market cap ranging from $2 billion to $10 billion, mid-cap stocks can be a great middle ground for investors. If you’re eager to tap into the benefits that come with a stock that’s still in the earlier stages of its growth, mid-cap stocks typically still offer plenty of room to run. And if you want more liquidity and less volatility than most small-caps, mid-cap stocks can give you that too. 

3) Large-Cap Stocks

Large-cap stocks are those that have market caps greater than $10 billion. This is a lrge category, as that number can be a lot higher than $10 billion too – for instance see Apple’s current cap above $2 trillion. Stocks this size tend to attract a lot of attention from mutual fund managers and other big-money institutional investors: the so-called “whales” of the market. These whales trade in much bigger blocks of shares than you and I ever will, which in turn pumps up the average daily trading volume of large-cap stocks. All of that liquidity tends to reduce large-cap stocks’ volatility, which can be a positive trait for investors who prefer more predictable price action in their holdings. 

The drawback is that many large-cap stocks move more slowly than their smaller-cap peers, so you’re not necessarily going to accrue huge gains very fast. Still, there are exceptions, such as Tesla (TSLA) surging sevenfold from its March 2020 lows to an all-time high in late August 2020.

Here are some examples

1) Small-Cap Stock

Sonos (SONO) is a California-based maker of wireless home audio products is a great small-cap stock at the moment. Home entertainment systems are gaining in demand thanks to the global COVID-19 pandemic that’s forced people to stay home far more than before. The stock more than doubled in price from the coronavirus-induced market scare of March 2020 to a new high in early August. With a market cap of about $1.5 billion, Sonos fits neatly into the small-cap category.

2) Mid-Cap Stock

Cabot Microelectronics (CCMP) manufactures slurries and pads used by chipmakers to build advanced integrated circuit devices for various electronic products. The stock fits the best-of-all-worlds profile common in a mid-cap: It’s got a $4.4 billion market cap, it’s up more than 70% in the past six months, and it even offers a 1.2% dividend yield for good measure.

3) Large-Cap Stock

With years of robust revenue and earnings growth, a brand name recognised around the world, and a market cap topping $800 billion, Facebook (FB) checks all the boxes as a powerhouse large-cap stock. The Internet services provider and social media giant recorded $70.7 billion in 2019, and that growth uptrend has continued through the global COVID-19 pandemic. 

How do I find stocks broken down by the size of their market caps?

You can find everything you need right here. We publish lists of top small-cap, mid-cap, and large-cap stocks on a regular basis right here on this site.

Hopefully, this has given you some useful insight as to how the market caps of stocks can and should influence your investment decisions. For an even broader look at the world of stock types, check out our next lesson on how market conditions affect different classifications of stocks.

By Jonah Keri
Jonah Keri is a trader and analyst who spent 11 years at Investor's Business Daily covering the markets. He now writes about stocks, cryptocurrencies, and other investments for Invezz and about emerging technologies for private clients.
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