Small cap vs large cap is a key concept in stock trading. Both small cap and large cap represent your ownership of stocks within a company. However, there are certain differences between the two. They both act differently in your portfolio.
Given the importance of the small cap vs large cap concept, we decided to help you. We are going to help you understand what are small cap stocks and large-cap stocks in this article. There are particular differences between both types and we are going to highlight those differences. So, keep reading and keep learning.
Small cap vs large cap definitions
Understanding market capitalization is imperative before heading forward to small cap vs large cap. So, what is market capitalization? Market capitalization refers to the total dollar value of all outstanding and restricted shares of a company. For example, if a company has total outstanding shares of $1 million and restricted shares of $200,000, its market capitalization is $1.2 million.
Now, let’s try to understand what a small cap is and what a large cap is. Small market capitalization or small cap companies have a total dollar value between $300 million to $2 billion. Whereas, large market capitalization or large cap companies have a total dollar value of more than $10 billion. Moreover, it is also important to note that share prices do not decide whether a company is a small cap or a large cap. For instance, company X has a share price of $20 while company Y has a share price of $50. So, this doesn’t mean that company Y is a large cap while company X is a small cap.
Small cap vs large cap – key differences
Here are the key differences between both types that will help you in differentiating small cap companies from large caps.
1. Market capitalization
As we discussed earlier, small market capitalization or small cap companies have a total dollar value between $300 million to $2 billion. Whereas, large market capitalization or large cap companies have a total dollar value of more than $10 billion. So, the overall dollar value of market capitalization difference is the key in small cap vs large cap.
2. Financial health
Another major difference between the two is small cap companies have low financial strength. They cannot afford to invest in high-growth segments. Conversely, large cap companies are very strong and have very good financial health. They have a strong balance sheet, income statement, and cash flow statement. Thus, they can invest in high-growth segments.
As you know, large cap companies have a strong balance sheet and a lot of cash in hand. Thus, they are more stable. Conversely, small cap companies are less stable as they have fewer resources to maintain their business. It is a simple difference between a small cap vs large cap.
As a simple rule, small cap companies are highly volatile. That means there is a great risk associated with investing in such companies. Conversely, large cap companies are less volatile and therefore, are less risky. That’s why risk-averse investors often prefer to invest in less risky and stable large cap companies. On the other hand, investors with higher risk tolerance invest in small cap companies with the potential to grow in the future.
5. Return on investment
Small cap companies with the potential to grow offer higher returns on investment. However, they are riskier as their share prices fall dramatically during a bear market. Contrarily, large cap companies are stable, less risky, and also offer a low return on investment. However, their share prices are not affected much by the bearish market.
6. Growth potential
Although large cap companies have lots of resources, their growth potential is low. Whereas, small cap companies always have higher growth potential. It is because when companies acquire large cap status, it indicates that the business is mature now. So, there is not much room for growth. Contrarily, small cap companies have higher growth potential.
Analyzing the performance of large cap companies is easy because of the readily available information. Big companies publish statements, newsletters, etc. Therefore, information is easily available. On the other hand, information about small caps may be available but it isn’t as detailed and comprehensive as for large caps. As a result, it becomes difficult at times to properly analyze small caps.
Another key difference between small cap vs large cap companies is dividends. As you know, large cap companies are mature and well-established. Therefore, they often don’t invest in business growth. Conversely, they prefer to return value to their investors through dividends. On the other hand, small cap companies don’t pay dividends because their focus remains on growth. They don’t have enough profits to distribute among investors as dividends.
Small cap vs large cap – which type should you choose for investment?
Well, this is a question that has no straightforward answer. Investors invest according to their trading strategy, trading style, and risk attitude. For example, you are a risk-seeker and looking for higher returns on your investment. It is obvious that you will prefer to invest in small cap companies. As you know, high risk, high rewards. Contrarily, risk-averse investors always prefer large cap companies and look for small returns.
Moreover, it is also important to analyze your period of investment. If you want to invest for a long time, both types are better. However, diversification is the better option. That means don’t limit yourself to one type of stock. Rather, you can build your portfolio by investing in both small and large cap companies. It will help you keep risk under control but maximize the overall return on your investment.