Large-Cap vs Small-Cap Stocks

The stock market is a great place to invest because there are many different strategies you can utilize. You can attempt to handpick winners for the highest possible gains or simply purchase index funds and ride the market’s overall return, depending on your risk tolerance. But for many investors and asset managers, the investment strategy in stocks leans in the middle of these two extremes.

One of the most common stock investment strategies is based on market capitalization. In this scenario, your allocation will usually contain certain proportions of large-cap and small-cap stocks. Large-cap stocks are the biggest companies in the market, while small-caps are new, growing firms.

What Are Large-Cap Stocks?

Market capitalization refers to the total value of all outstanding shares of a publicly-traded company. We tend to think that public companies are all large conglomerates, but raising money through capital markets isn’t just a privilege for the biggest firms. The definition of “large-cap” can vary depending on the publication, but the usual number is $10 billion or higher.

Large-cap stocks are older, established companies with a history of success. Large-cap companies are spread out across every sector and region, although you can narrow your investment strategy to just US large-caps through different funds. Large-cap companies might not have as much room for growth as smaller firms, but they do have consistency and stability that many investors find attractive.

Pros of Large-Cap Stocks

These are some of the pros of large-cap stocks:

  • Staying Power. Large-cap companies tend to have great track records. After all, you don’t grow to over $10 billion in market cap without sustained profits and success, do you? Large-cap companies have very little risk of bankruptcy, and sudden declines are rarer than their small-cap brethren.
  • Dividends. Lack of growth isn’t all bad, though. When a profitable firm no longer sees value in further expansion or research and development (R&D) efforts, some of those profits will be returned to shareholders through dividends. You might not get growth through the stock price, but you can expect your dividends to get bigger and bigger over time.

Cons of Large-Cap Stocks

These are some of the cons of large-cap stocks:

  • Less Chance of Exponential Gains. Investing in large-cap stocks can provide terrific returns, but they likely won’t be life-changing. One of the reasons so many funds track mostly large-cap indices like the S&P 500 is the diversity and stability these companies offer. However, over a long enough time period, small-caps can outperform large-caps because the winners in the small-cap field have so much more potential for stock price appreciation.
  • Lack of Growth. One of the problems with being large and established is that the room for growth has become thin. Small-cap stocks are more volatile, but they have longer to run since they haven’t established themselves in their industry.

What are Small-Cap Stocks?

Small-cap stocks aren’t exactly mom-and-pop shops, but they do pale in comparison to the size of the large-caps. Again, the definition can vary, but small-cap companies usually have a market capitalization between $300 million and $2 billion.

Small-cap companies are risky because they’re often new and still attempting to gain market share in their sector. Small-cap companies are cheap compared to large-caps when using measures like PE ratios and price-to-book value, but this low cost is balanced by volatility.

Pros of Small-Cap Stocks

These are some of the pros of small-cap stocks:

  • Potential for Outsized Gains. Small-cap stocks rarely pay dividends because most of their profits are plowed back into the company for R&D. Since these companies have a focus on gaining market share, the stock price of a quality small-cap can rise far more rapidly than large-cap firms.
  • Lack of Institutional Sway. Small-cap companies tend to fly under the radar from institutions and analysts, which may actually give individual investors an edge. It’s easier for small-cap firms to slip

Cons of Small-Cap Stocks

This is the primary con of small-cap stocks:

  • Brace for Volatility. When growth is the name of the game, you must accept the volatility that comes along with it. Small-cap firms are more volatile than their large-cap peers, which may turn off less risk-tolerant investors.

Work With an Experienced Financial Advisor

If you have any questions about large-cap and small-cap stocks or would like to review your portfolio, we’re here to help. A team member from Good Life Financial Advisors of Mount Pleasant is happy to assist you!

Disclosure

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk, including fluctuating prices and loss of principal.

Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.