Investing Basics – Market Cap Classifications

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Investing Basics – Market Cap Classifications

By Michael Tibbits, YouCanTrade

Market Cap Classification

Stocks are commonly separated into different classifications based on their market cap values. Below are the different classifications from smallest to greatest.

Nano- & Micro-Cap

Technically, a company with a market cap under $2 billion is considered a small cap stock. But, since there are thousands of companies that fall under this broad classification, investors created new terms to further categorize small cap stocks a bit more.

Nano-cap stocks are companies with less than $50 million in market capitalization. Nano-cap stocks are known for their volatility, and as such, tend to be considered riskier than companies with larger market capitalization. Nano-cap stocks share the same qualities as microcap stocks only they have smaller market caps.

Microcap stocks have a market cap between $50 million and $300 million. Like nano-cap stocks, micro-cap stocks also have a reputation for high risk because they lack a proven track record, have high volatility, and a lack of liquidity. These stocks tend to have wide bid ask spreads which can cause the appearance of gaps in their daily charts.

Many micro- and nano-cap stocks can be found on the over-the-counter (OTC) markets, rather than on major exchanges, such as the New York Stock Exchange (NYSE). Unlike stocks on national exchanges, companies listed on certain OTC markets do not have to meet minimum standards such as for net assets and numbers of shareholders.

In terms of variety, there are more microcap stocks to choose from compared to large cap stocks. However, quantity doesn’t always mean quality. Choosing from a group of stocks that are not listed on major exchanges makes investment decisions a bit difficult and time consuming. Investors often spend a considerable amount of time researching microcaps before investing money to avoid companies with poor fundamentals or fraudulent accounting practices.

Overall, micro- and nano-cap stocks may represent a high-risk, high-reward opportunity for investors who are willing to do more research on the company involved to determine whether it is worth the investment. This could include contacting the company directly to get the answers to any questions.

Small-Cap

Small-cap stocks are companies that have a market cap between $300 million and $2 billion. The stocks in this category are a step-up from the micro-caps. In general, small-cap stocks offer the most growth potential, but that growth comes with the more risk than their mid- and large-cap counterparts. Despite being larger than micro-cap stocks, small caps are still thinly traded, meaning there is a low number of shares being traded on a daily basis. The lack of market participation translates to longer waiting periods when trying to fill a buy or sell order.

Position sizing small-cap stocks may be ideal for an individual retail investor since they are typically more affordable than the mid- and large-cap stocks. Also, institutional investors do not usually participate as frequently in small cap offerings to avoid owning controlling portions of these smaller businesses. If they did, then the company would be required to issue a regulatory filing stating the amount of the company the institution owns.

Despite the risks, there are good reasons for investing in small-cap stocks. One reason 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 $10 million. Also, since smaller companies are less established, they can adapt and change their direction to meet market trends faster than larger companies can. This is much like doing a U turn, it is easier to do when driving a small car compared to a semi-truck.

Mid-cap

Mid-caps stocks are companies that have a market cap between $2-10 billion. As the name implies, a mid-cap company is between small- and large-cap companies. Mid-cap companies tend be well positioned, growing companies.  mid-cap stocks also tend to be “growth” stocks since they provide a balance of growth and stability.

During low interest rate environments, borrowing money becomes cheap and corporate growth is generally stable. Mid-cap companies are usually well positioned to qualify for the loans they need to grow, which is something smaller companies struggle with. Mid-caps may not be as risky as small-cap companies, which means they tend to do relatively well financially during times of economic turbulence. In addition, many mid-caps are well known, are often focused on one specific business and have been around long enough to make a niche in their target market.

Overall, mid-caps stocks are deemed to be less risky than small-cap stocks, but more risky than large-cap stocks. Successful mid-cap companies will usually see their market capitalization rise due to an increase in their share prices. Mid-caps generally have more growth potential and are riskier than large-caps; mid-cap stocks may outperform large-cap stock. However, share prices can rise to the point where mid-cap companies fall out of the mid-cap category and fall into the large-cap category.

Large-Cap

Large-cap stocks are companies that have a market cap of $10 billion or more. A popular trading term used to describe large-cap stocks is “blue chip” stocks. The name was inspired from the highest valued chips used in the game of poker: blue chips. These are the big and popular companies you have probably heard of like McDonald’s (MCD), Pfizer (PFE) and Nike (NKE).

Large-cap stocks tend to be less volatile during rough markets as investors fly to quality and stability and become more risk averse. So, if stability is what you want, you may want to take a look at large-cap stocks.

Large-cap stocks are listed on national exchanges, which requires regular filings with the SEC whenever significant changes occur within the company. This requirement makes it easier for investors to find and analyze public information about them.

Large-cap stocks also normally issue dividends since they have already passed their growth period and have established themselves to the point where they can afford to share the excess earnings among their shareholders.

The combination of stability and issuing dividends make large cap stocks an ideal choice for many portfolios. In fact, large cap stocks represent the majority of the U.S. equities markets. If you work in the United States and have a 401k, there is a good chance a portion of your retirement funds are being invested in large cap stocks.

However, everything has its pro and cons. Large-caps might offer the most stability, but in exchange for stability they usually have the least opportunity for growth. So, it can take a very long time to see higher returns on large cap stocks. Large-cap stocks also tend to be expensive. This limits the amount of shares the average retail investor can purchase because it ties up capital that could be otherwise used to diversify among other investments. Lastly, large-cap stocks tend to be leaders in their respective sectors which can act as a double-edged sword. Market news about these companies is typically impactful to the broad market overall. A bad earnings report or news release perceived negatively can inspire a sell off that can send the broader equities markets trading lower.

Mega-Cap

Mega-cap stocks are technically large-cap companies with market caps exceeding $200 billion. Since many companies fit within the category of large cap stocks, investors created a new term to further distinguish the largest of the large cap companies. These companies have strong brand recognition and operate in major markets around the world, such as Apple (AAPL), Amazon (AMZN) and Facebook (FB). Apple Inc. is the largest mega cap stock, surpassing a $2 trillion valuation.

Mega-cap stocks in the past have predominantly been in the energy or transportation sectors such as those in oil or railroads. Today, many of the largest companies in the world are tech companies that hold capitalizations over $200 billion and deliver consistent dividend payments and steady returns.

The number of Mega-cap stocks are increasing worldwide. China, for example, is home to two of the largest global companies, Tencent and Alibaba.

On a sector basis, the commodity boom of the early 2000s led to many energy and resource companies achieving mega-cap status. On the other hand, the dramatic decline of US and European banks following the 2008 credit crisis dragged some of the biggest banks below mega-cap status. And, today, the surge in innovative and disruptive technology lifted the entire sector and many of its constituents to new heights. Many of the largest companies in the US now have ties to cutting-edge technology but also boast significant returns.

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2021-04-20T15:19:52-04:00
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