Investing Basics: Small-Cap Stocks

Investing Basics: Small-Cap Stocks

Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn’t affect our editors’ opinions or evaluations. Small-cap stocks are shares of companies with total market capitalization in the range of about $300 million to $2 billion. Small-cap companies have the potential for high rates of growth, making them appealing investments, though their stocks may experience more volatility and pose higher risks to investors. Why Is Market Capitalization Important?

Market capitalization measures a publicly traded company’s total market value. You can calculate market cap by multiplying a company’s current stock price by the total number of shares outstanding. Market cap data is generally available for publicly traded companies on any website that provides real-time stock information.

Market cap is generally used to divide stocks into three categories based on size: large-, mid- and small-caps. A company’s size in terms of market capitalization doesn’t tell its whole story, but market cap information is useful for a variety of key decisions.

Market capitalization data is helpful for investors when they are evaluating the growth and risk prospects of stocks to include in their portfolios. Grouping companies of similar sizes together allows you to better compare their stocks and performance.

Index providers also use market cap to determine which companies should be included in benchmarks. These composition decisions directly impact which stocks are included in any index funds you own.

Actively managed funds rely on market cap designations as well. Fund managers may craft an investment strategy to focus on particular segments of stocks based on their market cap. And in the business world, companies could look for possible acquisition opportunities within small-cap competitors. What Are Small-Cap Stocks?

Small-cap stocks are the most numerous companies in the market. In fact, there are more small-cap stocks than large- and mid-cap stocks combined. That’s thanks to the fairly broad range of market capitalizations included in the small-cap stock designation: Anything from about $300 million to $2 billion can be considered a small-cap stock.

Because of their size, small-cap stocks have different risks and rewards for investors than their larger counterparts. Small-caps include the next hot company everyone will be talking about along with companies on the brink of bankruptcy, and ones that are prime targets for an acquisition.

As a result, small-cap stocks can experience larger-than-average volatility, which is just another way to refer to rapid gains and losses. Over long periods of time, investors may be rewarded if they stomach the ups and downs along the way. However, in the short term, some small-cap stocks may experience wild swings and can be illiquid , meaning they don’t trade as frequently and can be difficult to sell for cash.

In the past 20 years, the S&P SmallCap 600 index, a leading benchmark for small-cap stocks, has outperformed its related indexes for large- and mid-caps on an average annualized basis, according to figures from S&P Dow Jones Indices. During that period, the S&P’s benchmark small-cap index returned an average of 8.3% annually, compared to 8% and 6.3% from its mid- and large-cap counterparts, respectively.

The following indexes are often used as benchmarks for the U.S. small-cap universe. Both include companies in a variety of industries: Russell 2000 Index. The Russell 2000 Index includes approximately 2,000 of the smallest U.S. stocks. Companies had a median market cap of $1.2 billion as of September 2021.

S&P SmallCap 600 Index. The S&P SmallCap 600 Index tracks the performance of 600 small-cap companies, with a median market cap of approximately $1.4 billion as of September 2021.

Small-Cap vs. Mid-Cap Stocks

Mid-cap stocks are those whose market caps range from $2 to $10 billion. Beyond size, there are other important differences between small- and mid-cap stocks:

> Stage in the business lifecycle. Companies in the mid-cap space occupy a sweet spot: They may be more established in their respective industry with a more robust lineup of products or services than small-caps, but they aren’t yet the big household names everyone knows.

Geography. Both small- and mid-cap companies derive a majority of sales within their domestic economy. However, companies in the mid-cap space are more likely to begin operating outside their home country.

Growth. Both mid- and small-cap companies have big growth potential, depending on their industry. Mid-caps are more likely than small-caps to be involved in a merger or acquisition, which can propel their growth prospects.

Risk. As a group, mid-caps are considered less risky than small-caps because of their more established business models.

Volatility. Because of their lower […]

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