New investors will quickly run across the terms small-, mid- and large-cap companies, and they might wonder why a company is wearing a cap – of any size.
The term means market capitalization – the market value of all of a company’s existing shares. It is basically a company’s shares multiplied by the current market price of one share. Investors gauge a company’s price by this rather than by sales or assets. It is also an effective way to see how the economic downturn of 2008 affected the financial world. The total market capitalization was as high as $57.5 trillion in May 2008, slid to $50 trillion in August and then went down to $40 trillion in September 2008, according to the World Federation of Exchanges.
There are no hard rules about the values of each designation. One gauge says small-caps are less than $2 billion in value, mid-caps are up to $10 billion and large-caps are more than $10 billion. Others say mid-caps start at $5 billion and small-caps start at $1 billion. And still others have added more categories: mega-caps, more than $200 billion; micro-caps, $50 million to $300 million; and nano-caps, below $50 million.
The size makes a difference in investor expectation. Small-cap stock values can grow or shrink quickly. The gain may be great, but so is the risk. These companies can grow into mid- and large-cap companies, taking investors along for the ride. But they also have less to fall back on when times are tough. They can drop in a hurry, again taking their investors with them.
Large-cap companies, which make up half of total market capitalization, tend to be steady in their performance. They are usually the companies that dominate their industry and are not likely to grow any more enormous by percentage, or to shrink, for that matter. These entities are often devoted to maintaining their position. So the investments are usually steady.
Mid-caps are considered a mix of small-cap and large-cap. They often have ambitions to grow into a large-cap, but that drive can also lead them to take risks. The companies are still substantial and are not likely to take ill-advised risks.
Investors should assess their risk tolerance before deciding to invest in stocks. Then they can determine which class of companies to put their money into. Many mutual funds specialize in different groups, so investors can take advantage of company size characteristics but spread the risk at the same time. The funds that track indexes such as the S&P 500 focus on large- or mega-cap companies, which offer stability and slower growth. They usually stumble only in significant downturns such as those after the 9/11 attack and the financial meltdown of 2008.