What Is A Small Cap Stock?
The meanings of "big cap" and "small cap " are generally understood by their names: big-cap stocks are shares of larger companies and small-cap stocks are shares of smaller companies. Labels like these, however, are often misleading. If you don't realize how big "small-cap" stocks have become, you'll miss some good investment opportunities. (Find out if small-caps are the investment for you in Introduction To Small Caps.)
Scaling Up
Small-cap stocks are often cited as good investments due to their low valuations and potential to grow into big-cap stocks, but the definition of small cap has changed over time. What was considered a big-cap stock in 1980 is a small-cap stock today. This article will define the "caps" and provide additional information that will help investors understand terms that are often taken for granted.
First, we need to define "cap", which refers to market capitalization and is calculated by multiplying the price of a stock by the number of shares outstanding. Generally speaking, this represents the market's estimate of the "value" of the company; however, it should be noted that while this is the common conception of market capitalization, to calculate the total market value of a company, you actually need to add the market value of any of the company's publicly traded bonds.
The Big Boys
Big-cap stocks refer to the largest publicly traded companies like General Electric (NYSE:GE) and Wal-Mart (NYSE:WMT). These are also called the blue chip stocks. "Big" has also been believed to have less risk while "small" has implied more risk, but, as evidenced by Enron, this is not a good assumption to make. It is true, however, that the bigger they are, the harder they fall.
Ranking Caps
The definition of big/large cap and small cap differ slightly between the brokerage houses and have changed over time. The differences between the brokerage definitions are relatively superficial and only matter for the companies that lie on the edges. The classification is important for borderline companies because mutual funds use it 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
Mid Cap - $2 billion to $10 billion
Small Cap - $300 million to $2 billion
Micro Cap - $50 million to $300 million
Nano Cap - Under $50 million
These categories have increased over time along with the market indexes. In the early 1980s, a big-cap stock had a market cap of $1 billion. Today that size is viewed as small. It remains to be seen if these definitions also deflate when the market does.
Shifting Numbers
The big-cap stocks get most of Wall Street's attention because that is where the lucrative investment banking business is. These, however, represent a very small minority of publicly traded stocks. The majority of stocks are found in the smaller classifications, and this is where the values are. Below is a breakdown of the percentage of stocks in each cap category. This the actual number changes, but the percentages stay more or less the same. There were 17 mega cap stocks in 2007, but that number shrunk to less than five by 2010 due to the 2008 mortgage meltdown and the Great Recession.
Mega Cap: 0.1%
Big Cap: 3.5%
Mid Cap: 7.4%
Small Cap: 17.6%
Micro Cap: 18.8%
Nano Cap: 15.8%
The big and small labels are also attached to the major stock exchanges and indexes, which also leads to confusion. The Dow Jones Industrial Index 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 prior to 1990, but have since changed. Since the tech boom, the market caps of the stock exchanges and indexes vary and overlap. The average market cap for the Dow, however, remains much larger than the average market cap for the Nasdaq 100.
Bottom Line
Here are some main points to keep in mind:
• 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.
