Understanding Small-Cap and Big-Cap Stocks

The meanings of big-cap and small-cap are generally understood by their names, which indicate how valuable they are in terms of market capitalization. Big-cap stocks—also referred to as large-cap stocks—are shares of larger companies. Small-cap stocks, on the other hand, are shares of smaller companies.

Labels like these can often be misleading because many people run under the assumption that they can only make money by investing in large-cap stocks. And that can’t be further from the truth—especially nowadays. If you don’t realize how big small-cap stocks have become, you could miss some potentially promising investment opportunities.

Small-cap stocks are often attractive due to their lower relative valuations and potential to grow into big-cap stocks eventually, but the dollar-amount definition of a small-cap has changed over time. What was once considered a big-cap stock in previous decades may be thought of as a small-cap stock today. This article will define the caps and provide additional information to help investors understand terms that are often taken for granted.

Scaling up Stocks

Before we do anything else, we first need to define the word cap—which is short for capitalization. The term in its entirety, though, is market capitalization or market cap. This is the market’s estimate of the total dollar value of a company’s outstanding shares.

To get this figure, you need to multiply the price of a stock by the number of shares outstanding. One thing to keep in mind, though, is that though this is the common conception of market capitalization, you actually need to add the market value of any of the company’s publicly traded bonds to calculate the total market value of a company.

The market cap shows the size of the company, which is something of interest to most investors. That’s because it generally points out several of a company’s key characteristics, including its risk assessment. Although the value of small-cap stocks may vary from broker to broker, the general consensus today is that they have market caps ranging from $250 million to $2 billion.

One misconception people have about small-caps is that they are startup companies or are just brand-new entities that are breaking out. But many small-cap companies are just like their larger counterparts in that they have strong track records, are well established, and have great financials. And because they are smaller, small-cap share prices have a greater chance of growth. This means they have more potential for investors to earn money faster.

The Big-Caps

Big-cap stocks refer to the largest publicly traded companies, with market caps of more than $10 billion, like General Electric and Walmart. These companies are also called blue-chip stocks—companies with a history of dependable earnings, solid reputations, and strong financials. Some examples of blue-chip stocks are IBM Corp., Microsoft, Coca-Cola Co., and Boeing Co. Though companies like these tend to perform well and provide safe returns for investors, you should not see this as a blanket expectation for all large-caps.

In general, big-cap stocks are established, mature, and stable. They tend to be less volatile and reward investors with stable and growing dividend streams. However, some investors have the misconception that the large-cap moniker means there is no risk at all. There have been several cases in financial history that point to the opposite.

Enron is just one example. It serves to demonstrate that the bigger they are, the harder they fall. The company, which was a darling of the energy industry, was the subject of an accounting scandal. The company used mark to market (MTM) accounting to make the company look like it was much more profitable than it actually was. Its subsidiaries were losing money, but the company continued to hide its losses and debt, using off-balance-sheet entities to mask toxic assets. The company buckled and ended up filing for bankruptcy. Key personnel, including CEO Jeffrey Skilling and the company’s accounting firm, faced criminal charges.

The lesson? 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.

The Small-Caps

Small-cap stocks, as the name implies, are far smaller in terms of market valuation—but also, generally, scale, scope, and influence. These companies have a market cap of $250 million to $2 billion and are found in all business types, economic sectors, and growth phases.

One common misconception about small-caps is that they are startups or brand-new companies. In reality, many small-cap companies are well-established businesses with strong track records and great financials. And because they are smaller, small-cap share prices have a greater chance of growth.

Historically, small-cap stocks may have outperformed large-cap stocks. However, whether smaller or larger companies perform better varies over time from period to period based on other factors like the broader economic climate. For instance, big-caps seem to hold their own better during bear markets and recessions.

At the same time, small-cap stocks tend to be more volatile (and thus riskier) than their larger-cap peers. It often takes less trading volume to move their prices, and it is common for a small-cap stock’s price to fluctuate more in a single trading day than those of larger companies. That is something that many investors simply cannot stomach, but it does attract more active traders like day traders. Note that because these stocks often have less liquidity, it is also more difficult to exit a position at the market price.

Ranking Market Capitalizations

The definitions of big- or large-cap and small-cap stocks differ slightly from one brokerage company to the next and have changed over time. The differences between the brokerage definitions are relatively superficial and only matter for the companies that lie on their edges. The classifications are important for borderline companies because mutual funds use these definitions to determine which stocks to buy.

The current approximate definitions are as follows:

• Mega-cap: Market cap of $200 billion and greater
• Big-cap: $10 billion and greater, up to $200 billion
• Mid-cap: $2 billion to $10 billion
• Small-cap: $250 million to $2 billion
• Micro-cap: $50 million to $250 million
• Nano-cap: Under $50 million

These categories have increased over time along with the market indexes. And it is important to note that these definitions are fluid and not fixed—they are relative. For example, in several circles, stocks with market caps greater than $100 billion are seen as mega-caps.

Shifting Numbers

The big-cap stocks get most of Wall Street’s attention because that’s where you’ll find the lucrative investment banking business. Large-cap stocks make up the majority of the equity market in the United States, which is why they make up the nuclei of many investors’ portfolios.

Mega-cap stocks, on the other hand, tend to shift in numbers. There were at least 7 of these stocks in existence in 2007, but that number shrunk by 2010 due to the 2008 mortgage meltdown and the Great Recession. In the years since, mega-cap stocks have made a resurgence, and behemoths such as Apple (AAPL) and Microsoft (MSFT) have reached historic market-cap highs approaching $2 trillion each. As of 2022, the total number of mega-cap companies around the world is around 48.

But what about small-caps? Remember, just because they have a smaller market cap doesn’t mean you won’t find value or great returns. In fact, you can find much of the value in the stock market in small-cap stocks because some of them have some of the strongest track records around.

The Bottom Line

The big and small labels are also attached to the major stock exchanges and indexes, which also leads to confusion. The Dow Jones Industrial Average (DJIA) is viewed as consisting of only big-cap stocks while the Nasdaq is often viewed as being comprised of small-cap stocks. These perceptions were generally true before 1990, but have since changed. Since the tech boom, the market caps of the stock exchanges and indexes vary and overlap.

Labels such as big and small are subjective, relative, and change over time. Big does not always mean less risky, but the big-caps are the stocks most closely followed by Wall Street analysts. This attention, however, generally means that there are no value plays in the big-cap arena.