Small-Cap Stocks vs. Large-Cap Stocks - Holdun

Small-Cap Stocks vs. Large-Cap Stocks

“Small-cap” and “Large-cap” settles nicely into the realm of unnecessary business jargon. These terms simply refer to smaller and larger companies. The “cap” refers to market capitalization or the company’s total market value (price per share X total shares outstanding).

  • Small-Cap: Companies valued between $250 million and $2 billion
  • Mid-Cap: Companies valued between $2-10 billion
  • Large-Cap: Companies valued over $10 billion
Small-Caps
  • Younger companies and, therefore, theoretically more volatile
  • Tend towards a more aggressive growth strategy
  • Tighter business focus with less diversification
Large-Caps
  • Tend to be established, well-known companies
  • Stocks are less volatile
  • Growth tends to be slower overall
  • More likely to pay dividends than small-cap stocks

So, Which Is Better?

The “small company effect” describes smaller companies’ tendency to outperform larger ones over longer time periods. This was first discovered by the researcher Rolf Banz in 1981.

Lately, however, the superior returns of small-cap stocks are nowhere to be seen. Over the past five years, the S&P small-cap index has returned a cumulative 40% while its large company sibling has returned over 90%. Some believe that the small company effect has broken down due to the emergence of mega-cap tech companies with huge market share and deeper capital resources allowing them to use their economies of scale to force a competitive advantage.

The question is, will this trend continue forever or will conditions revert to the way they were. Any attempt to answer that question would have to look into the future scope of innovation and even antitrust laws.

The historical tendency for mean reversion would suggest that smallcap stocks now look cheap relative to the more expensive large-cap alternatives that have been on a recent run. Still, it’s anyone’s guess as to when this reversion will take place.

For now, maintaining some exposure to the growth prospects of small-caps while holding the core of your portfolio in more stable largecap stocks will offer stability, growth exposure, and some downside protection through diversification as gains in one area may help offset losses in another.