Small-Cap Stocks vs. Large-Cap Stocks: What’s the Difference?

Fact checked by Katrina MunichielloReviewed by Eric EstevezFact checked by Katrina MunichielloReviewed by Eric Estevez

Small-Cap Stocks vs. Large-Cap Stocks: An Overview

Historically, market capitalization, defined as the value of all outstanding shares of a corporation, has an inverse or opposite relationship to both risk and return. On average, large-cap corporations—those with market capitalizations of $10 billion and greater—tend to grow more slowly than mid-cap companies. Mid-cap companies are those with a capitalization between $2 billion and $10 billion, while small-cap corporations have between $250 million and $2 billion.

These definitions of large cap and small cap differ slightly between the brokerage houses, and the dividing lines have shifted over time. The differing definitions are relatively superficial and only matter for the companies that are on the borderlines.

Key Takeaways

• Publicly traded companies are often segmented by their market capitalization—that is, the total value of their shares in the market.
• Large-cap corporations, or those with larger market capitalizations of $10 billion or more, tend to grow more slowly than small caps, which have values between $250 million and $2 billion.
• Large caps tend to be more mature companies, and so are less volatile during rough markets as investors fly to quality and become more risk-averse.
• Shares of small caps and midcaps may be more affordable for investors than large caps, but smaller stocks also tend to have greater price volatility.

Small-Cap Stocks

Small-cap stocks have fewer publicly traded shares than mid- or large-cap companies. As mentioned earlier, these businesses have between $250 million and $2 billion of the total dollar value of all outstanding shares—those held by investors, institutional investors, and company insiders.

Smaller businesses will float smaller offerings of shares. So, these stocks may be thinly traded and it may take longer for their transactions to finalize. However, the small-cap marketplace is one place where the individual investor has an advantage over institutional investors.

Since they buy large blocks of stocks, institutional investors do not involve themselves as frequently in small-cap offerings. If they did, they would find themselves owning controlling portions of these smaller businesses.

Lack of liquidity remains a struggle for small-cap stocks, especially for investors who take pride in building their portfolios on diversification. This difference has two effects:

1. Small-cap investors may struggle to offload shares. When there is less liquidity in a marketplace, an investor may find it takes longer to buy or sell a particular holding with little daily trading volume.
2. The managers of small-cap funds close their funds to new investors at lower assets under management (AUM) thresholds.

Large-Cap Stocks

Large-cap stocks—also known as big caps—are shares that trade for corporations with a market capitalization of $10 billion or more. Large-cap stocks tend to be less volatile during rough markets as investors fly to quality and stability and become more risk-averse.

These companies comprise over 90% of the American equities marketplace and include names such as mobile communications giant Apple, multinational conglomerate Berkshire Hathaway, and oil and gas colossus Exxon Mobil. Many indices and benchmarks follow large-cap companies such as the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 (S&P 500).

Since large-cap stocks represent the majority of the U.S. equity market, they are often looked at as core portfolio investments. Characteristics often associated with large-cap stocks include the following:

1. Transparent: Large-cap companies are typically transparent, making it easy for investors to find and analyze public information about them.
2. Dividend payers: Large-cap, stable, established companies are often the companies investors choose for dividend income distributions. Their mature market establishment has allowed them to establish and commit to high dividend payout ratios.
3. Stable and impactful: Large-cap stocks are typically blue-chip companies at peak business cycle phases, generating established and stable revenue and earnings. They tend to move with the market economy because of their size. They are also market leaders. They produce innovative solutions often with global market operations, and market news about these companies is typically impactful to the broad market overall.

Key Differences

There is a decided advantage for large caps in terms of liquidity and research coverage. Large-cap offerings have a strong following, and there is an abundance of company financials, independent research, and market data available for investors to review.

Additionally, large caps tend to operate with more market efficiency—trading at prices that reflect the underlying company—also, they trade at higher volumes than their smaller cousins.

Small-cap stocks tend to be more volatile and riskier investments. Small-cap firms generally have less access to capital and, overall, not as many financial resources.

This makes it difficult for smaller companies to obtain the necessary financing to bridge gaps in cash flow, fund new market growth pursuits, or undertake large capital expenditures. This problem can become more severe for small-cap companies during lows in the economic cycle.

Note

There are many small-cap and large-cap exchange-traded funds (ETFs) for investors to choose from that will provide a wide breadth of exposure to such companies without the need of having to choose individual stocks.

Despite the additional risk of small-cap stocks, there are good arguments for investing in them. One advantage is that it is easier for small companies to generate proportionately large growth rates.

Sales of $500,000 can be doubled a lot more easily than sales of $5 million. Also, since a small, intimate managerial staff often runs smaller companies, they can more quickly adapt to changing market conditions in somewhat the same way it is easier for a small boat to change course than it is for a large ocean liner.

Likewise, large-cap stocks are not always ideal. As mature companies, they may offer fewer growth opportunities and may not be as nimble to changing economic trends. Indeed, several large companies have experienced turmoil and have lost favor.

Just because it’s a large cap, doesn’t mean it’s always a great investment. You still have to do your research, which means looking at other, smaller companies that can provide you with a great basis for your overall investment portfolio.

What Are Small-Cap Stocks?

Small-cap stocks are the shares of companies with a market cap of between $250 million and $2 billion. These are companies that are smaller than the brand-name companies that are often part of the S&P 500.

How Do You Invest in Small-Cap Stocks?

One of the best ways to invest in small-cap stocks is by investing in small-cap exchange-traded funds (ETFs); those that track small-cap indexes. Such funds include iShares Core S&P Small-Cap ETF, iShares Russell 2000 ETF, and Vanguard Small-Cap ETF.

How Do You Invest in Large-Cap Stocks?

The S&P 500 index tracks the 500 largest companies in the U.S. by market cap. Investing in any fund that tracks this index will allow you to invest in a wide array of large-cap stocks. You can also choose other large-cap funds that invest in other large-cap indexes.

The Bottom Line

Small-cap stocks and large-cap stocks both come with their own pros and cons. While small-cap stocks can generate higher returns, they also have a higher risk profile. Conversely, large-cap stocks witness smaller growth but are more stable. Investors should consider investing in both for a balanced portfolio.

Read the original article on Investopedia.