Small Cap Companies versus Large Cap Companies

Sometimes, the dichotomy on the better option can pose a challenge to an investor because a large cap company doesn’t automatically mean you will get more returns.

Market capitalization is a tool that helps you determine the size of a company in comparison with others in the stock market or in whatever industry it is in. Commonly known as “market cap”, it represents the value of a company’s outstanding shares.

As such, it serves as a method to correctly determine the difference between small companies or large companies. There are many reasons why you will opt for a small company and chief on the list is that it has a myriad of opportunities at its disposal and this gives it capacity for growth.

There are also reasons an investor will also opt for large company stocks and a core reason is that they provide stability. Sometimes, the dichotomy on the better option can pose a challenge to an investor because a large cap company doesn’t automatically mean you will get more returns.

Here’s a breakdown of what both of them present as opportunities and the inherent risks they come with:

Small Capitalization Stocks/ Companies

Small cap stocks are generally small companies. They are known to have narrow business lines, not enough resources, and are prone to probably all of the other risks small businesses face.

As a result of this instability, their volatility is very high with prices moving at the slightest inclination from the forces of the stock market amongst other things. However, their opportunities are amazing.

Imagine the guys who invested in Facebook and Amazon when they were newbies in the game as opposed to investing in big names like General Electric? While it must have seemed like a huge risk at the time, the gains of those investors now are in no way comparable to those invested in safe high cap stocks.

With small cap stocks, you can bet that the risk will be higher because you are betting on them to grow amidst all the forces trying to crush them. Here lies the tradeoff.

Large Capitalization Stocks/ Companies

As you can imagine, large cap stocks belong to the stable companies that could have as much as centuries worth of experience in whatever business they invest in. they generally have large shares of the market, customer goodwill, and all the tools that give investors a perception of stability.

The term “Too big to fail” is sometimes used to talk about these systematically important companies because of their contribution to the economies they exist in as a result of their size.

However, because there isn’t so much room to grow anymore, large cap companies are great for dividend investors who want consistent income and not those who are interested in growth. Of course, these companies still have opportunities to divest into more business streams in addition to the many they already have.

They have structures and could have high stock prices. This stability makes it a choice for most risk-averse investors as they are dependable. It also means that they generally wouldn’t wake up and crash without signs.

Note To The Investor

Large cap companies will offer slightly lower returns because of their low risk. On the flip side, small cap stocks have low valuations and have the potential to become large caps over a period of time. Also, note that the threshold with what passes as large or small changes over time.

In other words, the amount in previous time that was considered to be for a large cap company is now considered as a small one as a result of the changing times.

Yet, the biggest advice is that neither should be overlooked when setting up your investment portfolio. Since one has a direct benefit over the other, there is no better tool for hedging and risk management than this form of portfolio diversification.

What happens is that depending on your investment objective, you can allocate more to either large cap stocks or small cap stocks. But neither is the enemy.

Written by Lawretta Egba.