If you’re looking at investing in stocks, your first instinct may be to purchase large-cap stocks as they’re lower in volatility and have greater analyst coverage. While that’s not necessarily wrong, you should look at both small and large-cap stocks as it’ll help to diversify your portfolio and deal with volatility.
Each stock also comes with its own pros and cons that may make them more attractive in certain situations or for a particular type of investor. In recent months, however, the spotlight has been shone on small-cap stocks due to their growth potential.
Size of both stocks
Large-cap and small-cap stocks are both categories of stocks that are measured by size. The term ‘cap’ refers to market capitalization – a way of measuring a company’s size. As a rule of thumb, large-cap stocks usually have a market capitalization of $10 billion or more, while small-cap stocks hover between $250 million and $2 billion. This, however, can differ based on the stock exchange that you’re looking at.
Most of the stocks available to the public are large-cap stocks and include companies such as Apple, Amazon, and Google. On the other hand, small-cap stocks have fewer publicly-traded shares, and it may take longer for transactions to finalize. An excellent benefit of purchasing small-cap stocks, however, is that institutional investors are not as involved in small-cap offerings, so competition isn’t as fierce as large-cap stocks.
In comparison to large-cap stocks, small-cap stocks tend to have higher growth prospects. As smaller companies are younger and seek to achieve aggressive growth, they offer larger potential gains when it comes to the share price and a higher return for investors. The volatility in the returns is also more significant, and the monthly total returns can even be 18% higher for small-caps than large-caps.
On the other hand, large-cap stocks are already so big that it is challenging to achieve massive growth.
Risk of investment
When it comes to the risk of investment, however, small-caps are riskier than large-caps. Why? These companies are smaller, so there’s always the risk of management being inexperienced, lacking resources, and having less access to capital. While there are risks, having a smaller group of managerial staff also means that the company can quickly adapt to changing market conditions. You’ll also have far less competition as small-cap companies usually receive minimal coverage from analysts and are typically undervalued with high returns.
In contrast, large-cap stocks usually have a proven track record and a broad range of products. They also tend to have a strong following, and there’s an abundance of information on large-cap stocks that’s readily available online. Unlike small-cap stocks, however, they may not be able to adapt as quickly to economic trends.
Use of dividends
Large-cap stocks are also attractive to investors because there’s a good amount of dividends that help to provide a steady source of income to investors. On the other hand, small-cap stocks typically don’t offer the same amount of dividends to investors as most smaller companies use those profits to grow their company further.
Which stocks should you pick?
There isn’t a right or wrong answer when it comes to selecting your preferred stock. Ideally, however, you should have both big-cap stocks and small-cap stocks to diversify your portfolio. Small-cap stocks are also appropriate for more aggressive investors that have long-term time horizons and a higher tolerance for risk.
During this tumultuous time, it’s a good idea to take a look at small-cap stocks as they’re inexpensive and tend to bounce back after a recession. If you’re new to investing and aren’t quite sure where to start, you can seek out help from investment professionals or look for a company that can help you with your investing needs.
Author bio: Luke Fitzpatrick has been published in Forbes, The Next Web, and Influencive. He is a guest lecturer at the University of Sydney, lecturing in Cross-Cultural Management and the Pre-MBA Program. Connect with him on LinkedIn.