Stocks represent ownership in companies of various sizes. Some may
be corporate giants with household names like Microsoft and General
Electric. Others may be industry newcomers with revenue and
resources a fraction the size of their larger brethren, but with
the potential for rapid growth, as well as greater risk.
Understanding the relationship between company size, return
potential, and risk is crucial if you’re creating an investment
strategy designed to help you pursue long-term financial goals.
With that knowledge you’ll be better prepared to build a balanced
stock portfolio that comprises a mix of market caps.
Typically, companies are categorized in one of three broad groups
based on their size — large-cap, midcap, and small-cap. Cap is
short for market capitalization, which is the value of a company on
the open market. To calculate a company’s market capitalization,
multiply its stock’s current price by the total number of
outstanding shares. For example, if a company issues one million
shares of stock trading for $50 each, its market capitalization
would be $50 million ($50 times 1,000,000 shares).
Definitions of the different market-cap categories may differ —
from one mutual fund company to another, for instance — but here
are some examples:
- Large-cap company — market value of $10
billion or more.
- Midcap company — market value between $3
billion and $10 billion.
- Small-cap company — market value of $3
billion or less.
Corporations with valuations of less than $1 billion are sometimes
referred to as microcap companies. Of course, companies often grow
and shrink in size with the passage of time. Microsoft, today one
of the world’s largest companies, was once run on a shoestring. And
given the changing nature of the marketplace, who knows what
tomorrow may bring?
Generally, market capitalization corresponds to where a company may
be in its business development. So a stock’s market cap may have a
direct bearing on its risk/reward potential for investors looking
to build a diversified portfolio of investments.
Large-cap stocks are generally issued by mature, well-known
companies with long track records of performance. Large-cap stocks
known as “blue chips” often have a reputation for producing quality
goods and services, and a history of consistent dividend payments
and steady growth. Large-cap companies are often dominant players
within established industries, and their brand names may be
familiar to a national consumer audience. As a result, investments
in large-cap stocks may be considered more conservative than
investments in small-cap or midcap stocks, potentially posing less
risk in exchange for less aggressive growth potential.
Midcap stocks are typically issued by established companies in
industries experiencing or expected to experience rapid growth.
These medium-sized companies may be in the process of increasing
market share and improving overall competitiveness. This stage of
growth is likely to determine whether a company eventually lives up
to its full potential. Midcap stocks generally fall between large
caps and small caps on the risk/return spectrum. Midcaps may offer
more growth potential than large caps, and possibly less risk than
Small-cap stocks are issued by young companies that generally serve
niche markets or emerging industries, such as those in the
technology sector. Small caps are considered the most aggressive
and risky of the three categories. The relatively limited resources
of small companies can potentially make them more susceptible to a
business or economic downturn. They may also be vulnerable to the
intense competition and uncertainties characteristic of untried,
burgeoning markets. On the other hand, small-cap stocks may offer
significant growth potential to long-term investors who can
tolerate volatile stock price swings in the short term.
|Measuring Returns — Using a Proper
A standard method of gauging the performance of an investment is
To adequately measure how well or poorly an investment is doing,
The Russell 2000 is a prominent index for small-cap stocks,
Each group of stocks may be influenced differently by current
So what does a company’s size have to do with your investment
strategy? Quite a bit. Over time, large-cap, midcap, and small-cap
stocks have tended to take turns leading the market (see table).
Each can be affected differently by market or economic
developments. That’s why many investors diversify, maintaining a
mix of market caps in their portfolios. When large caps are
declining in value, small caps and midcaps may be on the way up and
could potentially help compensate for any losses.
To build a portfolio with a proper mix of small-cap, midcap, and
large-cap stocks, you’ll need to evaluate your financial goals,
risk tolerance, and time horizon. A diversified portfolio that
contains a variety of market caps may help reduce investment risk
in any one area and support the pursuit of your long-term financial
Keep in mind, diversification does not eliminate risk or the risk
of potential loss.
- Company size is often referred to as market capitalization,
which is the value of a company on the open market.
- Market cap definitions vary, but in general large-cap companies
have a cap of $10 billion or more; midcap companies have a cap
between $3 billion and $10 billion; and small-cap companies have a
cap of $3 billion or less.
- A stock’s market cap may have a direct bearing on its
- A diversified portfolio that contains a mix of market caps may
help reduce investment risk in any one area and support the pursuit
of long-term financial goals.
- It’s important to use the right index when gauging the
performance of an investment in a particular market-cap
© 2010 Standard & Poor’s Financial Communications. All