What are small, mid and large cap stocks

What makes a mid-cap stock?

If you’re wondering what defines an equity as a mid-cap stock rather than a large-cap or small-cap stock, you’re in the right place. Mid-cap stocks are those with more modest market capitalisations than large-cap equities. Please note: Market-cap category definitions vary by index/provider/market; thresholds are indicative only and not universal.

They are usually in the range of $2-$10 billion. However, they also tend to have more headroom for growth in the context of the ceiling of their respective share prices. In addition, mid-cap corporations can improve their annual earnings at faster rates than those of well-established large-cap conglomerates. This gives shareholders in mid-cap equities the opportunity to receive periodic dividends as well as benefits from increased share prices.

Mid-cap stocks also tend to be more sensitive to volatility in the market, which gives patient traders the ability to go long on a mid-cap stock at discounted prices on occasion. This is a particularly attractive option for those looking to add a mid-cap stock to their investment portfolio with the potential to grow into a large-cap equity in the long term.

Another beneficial reason to invest in a mid-cap stock is the potential for the company to be involved in mergers and acquisitions (M&Q) with bigger firms. Mid-cap stocks that post impressive revenue growth may be on the radar of more established conglomerates in the same industry, with the potential for them to acquire the mid-cap stock and bring all their expertise in-house.

In this scenario, existing shareholders of the mid-cap stock are often given a preferential price for their shares to accept the buyout.

What makes a small-cap stock?

There are several characteristics of a small-cap stock that differentiate it substantially from large and even mid-cap stocks. First and foremost small-cap stocks are more likely to post higher returns in share price, as the value of its stocks have not fully matured like a large-cap stock.

Equally, small-cap stocks are just as likely to post significant losses as higher returns, such is the volatility of small-cap equities that are most susceptible to industry and macroeconomic headwinds.

Small-cap stocks are also lesser-known corporations. That doesn’t mean they aren’t worthwhile investments. It just means investors need to conduct more detailed research on these equities to determine their growth prospects.

On a stock-by-stock basis, small-cap equities tend to carry greater risk than mid and large-cap stocks. However, when combined with a diversified portfolio of large and mid-cap equities, it’s possible to find small-cap corporations that have the potential to yield bigger, faster returns.

For a listed company to be considered a small-cap stock, its market cap should be valued in the region of $300 million to $2 billion.

The main differences between small, mid and large-cap companies

What are the dynamics that define a small-cap stock from a large-cap stock? Below, we explore the nuances of small, mid and large-cap stocks to help you understand the pros and cons of each asset type before incorporating them into your investment portfolio.

Growth potential
There is a significant difference in the growth potential of large-cap and small-cap stocks. Typically, large-cap stocks have already achieved a significant amount in their respective markets and have a more stable existence as an established player.

Meanwhile, small-cap stocks are the ‘new kids on the block’ and have a much higher ceiling for future growth. However, with that higher ceiling comes greater risk and the chance their potential is unfulfilled. Those seeking more moderate growth and less turbulence than a small-cap stock should consider a mid-cap equity.

Investment risk
The risks for investors differ greatly between small, mid and large-cap equities. Large-cap stocks tend to have greater demand and liquidity, with the ability to withstand volatility.

Mid-cap stocks often have a higher growth potential than large-cap firms, with the ability to yield bigger returns over the short-to-medium term. However, they are more susceptible to volatility.

Small-cap equities carry the greatest risk exposure for investors as these companies are still in their relative infancy compared with bigger firms. Some are just as likely to fail as continuing to expand. 

Liquidity
Liquidity is rarely an issue for large and mid-cap stocks. This means there is usually plenty of money on both sides of the order book, looking to buy and sell their shares. Shares in large and mid-cap stocks can usually be bought and sold without affecting the overall share price.

Small-cap stocks typically have the lowest liquidity out of the three stock types as they tend to attract fewer investors.

Market volatility
Large-cap equities are less susceptible to market volatility. Even in less certain economic conditions, the share price on these established corporations is relatively stable. That’s why they are often viewed as low-risk investment options.

Mid-cap and small-cap stocks are more exposed to market volatility as their liquidity is often much lower and their respective share prices can fluctuate that much faster.

Commercial stature
It goes without saying that large-cap stocks are typically some of the biggest and most established listed companies in an industry. Large-cap firms may have thousands of employees and a global customer base.

At the other end of the spectrum, small-cap stocks are generally viewed as ‘up-and-coming’ brands or companies. These small-cap equities may be attempting to disrupt or innovate a sector to get a foothold in the marketplace. As for mid-cap stocks, their commercial reputation is somewhere in between the other two.

How often are equities ranked?

So, now that we know how equities are ranked based on their market performance, it’s also useful to understand how often these classifications are reviewed.

It’s true that the classification of equities as small, mid and large-cap stocks – and their reclassification to move from small to mid-cap, for example – does happen, but with little regularity. As many more listed companies have entered the financial markets, the stock rankings have had to evolve over time.

What used to be considered a large-cap stock 30 years ago may now only be considered a small-cap equity. The thresholds for defining small, mid and large-cap stocks are by no means definitive, but as you gain experience in the stock market you should be able to differentiate between them.