Stocks of publicly traded companies are ranked by capitalization, which is calculated by multiplying the current stock price by the number of shares outstanding. Stocks of companies with capitalization under $2 billion are considered small-cap; stocks of companies with capitalization over $10 billion are considered large-cap; and the ones in-between are considered mid-cap. The breakdown is approximate, with several additional sub-categories, but is generally useful because of the numerous and substantial differences between small-cap and large-cap stocks.
Companies start out small. Competition among them is fierce; many fail, but some succeed and grow. As they grow sales and earnings, add new products and expand into new areas or markets, they issue additional stock to raise capital, and their stock price increases over time. A small company may become a mid-cap, then a large-cap, but as it gets bigger its growth slows.
Opportunity vs. Risk
Small caps offer the biggest profit opportunities, but come with above average risk. A successful small company can grow several fold, with a corresponding increase in stock price, but if it fails, its stock will crash. A large-cap company has limited space to grow larger; its stock price has less upside potential but is more stable and is less likely to crash.
Stock Price Fluctuation
On balance, small-cap stocks fluctuate more than large-cap stocks. Most small companies are little known and unproven; their fortunes are often tied to a single product or service. Small cap investors are aggressive and unforgiving: they may bid up a small cap’s stock price to dizzying highs if they are bullish, and dump it just as quickly if they are disappointed, sending the price down sharply. Large-cap stocks are more stable: there are few surprises in their established businesses, they are well researched and followed by many stock analysts, and their stocks are held by multiple institutions -- all of which adds stability to the stock price.
A small-cap stock can produce much larger gains than a large-cap stock, but gains in one small-cap stock can be easily offset by losses in several others. Large-cap stocks also go up and down, but their moves tend to be less dramatic, with smaller gains and smaller losses, although there are always exceptions and a large cap company can grow into a mega cap, with capitalization in the hundreds of billions, rewarding investors with huge profits. As groups, however, small- and large-cap stocks have historically taken turns outperforming each other.
- “One Up on Wall Street”; Peter Lynch; 2000
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