Within investment styles, it is common to aggregate assets by market capitalization.
To find a company’s market capitalization (or “cap”), multiply current share price by number of shares outstanding.
Market capitalization is useful in comparing companies of similar size. Understanding the differences between each size segment is useful. For example, how you analyze large cap stocks will differ from micro cap equities.
Also, stocks in the same segment often respond to similar variables. Global behemoths may be impacted by an earthquake in Japan. Whereas, business tax policies in Canada may be more important to small Canadian based companies.
You will not need to calculate market caps, but you should understand the general differences between cap segments.
So what are the different segments?
Market Capitalization Segments
You will always see three market capitalization segments: large-cap, mid-cap, small-cap.
Less common are three additional categories: mega-cap, micro-cap, nano-cap.
These terms have some flexibility in usage and in ranges for each segment. I will provide the common categories, but be aware that you may see slightly different terminology and different ranges at times.
However, the general concepts are applicable. Big is big, small is small, and how companies operate within their specific market cap will differ versus other caps. Also, external factors impact companies differently depending on market cap.
Segment Ranges
Over $200 billion (US dollars) are the mega-cap companies. Some consider $100 billion the hurdle. Big, big, companies. Normally with a global presence. Microsoft (market capitalization of $491 billion in December 2016), Google ($560 billion), Apple ($616 billion) and Exxon ($384 billion) are examples of these extremely large companies.
Between $10 billion and $200 billion are large-cap. Some use $5 billion as the low end. May be referred to as “big-cap”. If mega-cap is not used by the rater, they are included in the large-cap segment.
$1 billion to $10 billion are mid-cap.
$300 million to $1 billion are small-cap.
$50 million to $300 million are micro-cap.
Below $50 million are nano-cap.
If micro or nano are not utilized, these segments will be part of the small-cap segment.
Ranges May Differ
Raters Use Different Ranges
Some investment professionals, mutual fund companies, or ratings agencies may use different terms and/or ranges for the market segments. Do not become fixated on terms or ranges. Just understand the general breakdown and know that large cap is different from small cap.
Investopedia groups companies between $300 million and $2 billion as part of their small-cap segment.
Morningstar utilizes percentages to segment stocks. Equities are divided into 7 geographic regions. Within each region, the top 40% of stocks are classified as giant-cap. The next 30% are large-cap, the next 20% are mid-cap and the last 10% are deemed small-cap.
With this Morningstar system, internal and external comparisons may be difficult.
Perhaps a stock construed as a large-cap in Latin America is only a mid-cap in the Greater Europe region. This makes internal comparisons of global companies within the Morningstar system harder than by using a fixed dollar calculation.
May Become Apples to Oranges Comparisons
Second, it makes external comparisons between rating organizations difficult. Morningstar has Canada as a unique region, so the bottom 10% of Canadian companies in size are considered small-cap. But unless I know the exact cut-off point, it is hard to compare to someone that uses a threshold of $1 or $2 billion for Canadian firms.
When assessing stocks as large, mid, or small-cap, do not blindly accept the classification by the organization that segments the equity. Do your own analysis to ensure that, in your own mind, you know what type of company it is.
Why is Market Capitalization Important?
Bigger Companies May Be Safer
First, investors often view larger companies as being more stable in nature, less risky, with broad operations that smooth earnings over time. Many large companies are considered “blue chip” investments because of their size, longevity, and the fact that they are a known business. Think Coca-Cola, Google, Nestle, HSBC, etc.
Smaller companies may be seen as riskier. Perhaps due to lack of public awareness, niche markets, lack of longevity, or merely due to a regional presence. Freenet AG (Germany), Coherent Inc. (US), Pigeon Corp (Japan) are small caps. You may not have heard of them, or most other small companies.
This may be how investors view the different market caps. Bigger is safer. Not necessarily true. But bigger and better known may make investors feel safer.
As a result, lower risk investors may prefer larger cap companies. More aggressive may seek out small cap.
Market Caps Fluctuate
Second, market capitalization may fluctuate over time based on how a company’s share price performs, as well as the number of outstanding shares it has. Many small-cap companies aspire to increase their share value so as to move up into mid, or even large-cap, segments.
Many of today’s mega cap companies once began as small cap stocks. In fact, many investors target small companies trying to find the next Apple or Microsoft before they make it big.
Some companies slip over time to lower segments. Being large is not protection from declines in value.
Consider the Canadian telecommunications company, Nortel. Once the darling of Canadian investors. In September 2000, its market capitalization was CAD 398 billion and it employed almost 100,000 staff around the world. A well-known, stable company that easily fit the mega cap segment.
Less than two years later, Nortel was worth under CAD 5 billion. By 2009, shares were trading at CAD 0.19 and the company was delisted.
If you had wanted to invest only in large or mega-cap equities and bought Nortel in 2000, you would have found yourself owning a small-cap stock very quickly. And in a further few years, worthless paper.
What goes up can also come down. Sometimes in a hurry.
Larger Usually Means More Liquidity
Third, the larger the capitalization, the more shares are outstanding, which normally translates into increased liquidity for investors. Liquidity risk is a real issue for investors.
When investing in nano or micro-cap companies, you may find it difficult to buy or sell shares on a timely basis and/or at your target price. This may also be the case for small-cap stocks.
Reduced liquidity can increase the price volatility (risk) of an asset. That is why smaller capitalized companies are generally considered riskier than larger companies. This has little to do with the risk of the company and its business. Just being able to buy and sell shares quickly with minimal price impact.
Liquidity risk is one big reason why many funds do not purchase shares in very small companies.
If you are the asset manager of a fund with $10 billion in assets, does it make sense to buy shares in a company with a market cap of only $1 billion or less? Say the fund purchases 2% of the company for its portfolio. Now the fund owns stock of $20 million. Or 0.2% of the fund’s assets. Regardless if the company thrives, stagnates, or crashes, it will not have a major impact on fund performance.
Yet if the fund tries to purchase (or later sell) 2% of a small, relatively illiquid, company in the open market, that will move share price significantly. In the wrong direction for the fund.
Note that there tend to be limits on percent ownership in public companies. Often 5% is a threshold. Any more and regulatory complications arise.
Larger Means More Investor Information
Fourth, smaller stocks typically have less publicly available information. I am not referring to corporate filings, such as annual reports or statutory documents. More in respect of investing information.
Many small companies are not actively followed by analysts. Public research or recommendations may be limited. This is compounded by the fact that industry peers are also small firms with relatively little investment information.
The less available information, the less transparency, the greater the investment risk.
Larger May Mean a More Level Field
Fifth, small-cap firms may be closely held by insiders or others connected to the company. While one cannot legally trade on inside information, insiders do have better access to company data and tend to do better than non-insiders.
If you are buying or selling shares in a small company, the counter-party may be someone with more knowledge of the stock than you. This further increases your risk. Whereas if you are buying or selling Apple or Nestle, there are so many shares outstanding that your counter-party is likely someone with similar knowledge as you relating to the company.
When considering investments in small-cap or smaller stocks, be careful.
Key Takeaways
Equities are usually grouped by market capitalization, especially in mutual and exchange trade fund classifications.
Exact splits between segments vary depending on who is classifying the stocks. Ensure you know what ranges make up the segments for the classifier you deal with.
Exact splits are not that important. But understand the broad categories and the characteristics of each. The bigger the company, usually: more information is available for investors; more institutions own the stock; liquidity is better.
The smaller the company, the opposite. Liquidity risk is always a concern. As well, the lack of public information you can obtain and the fact that you are often trading with in-the-know insiders can increase your risk.
