This is a continuation from Categories of Stocks and Identifying Them Correctly for Diversification Purposes Part 1, where we discussed on the Cyclicality of Industry. In this part, we will cover Size next.
To recap, the 7 classifications are:
1. Cyclicality of Industry
3. Growth Potential / Maturity Level
4. Business Fundamentals
5. Dividend Levels
6. Economic Moats
7. Location of Markets
Size – Micro Cap, Small Cap, Mid Cap, Large Cap or Mega Cap
The company can also be classified by the size of its market capitalization (Stock Price x Shares Outstanding). Depending on the exchange, the values for classifying micro, small, mid, large and mega cap can be vastly different.
For US Listed Stocks
Micro Caps are generally penny stocks with a market cap of $50mil – $300mil e.g. Armour Residential REIT
Small Caps are generally small, new companies with a market cap of $300mil – $2bil e.g. Cirrus Logic
Mid Caps have a market cap of $2bil – $10 bil e.g. SalesForce.com
Large Caps are generally known to be called blue chips with a market cap of $10 bil – $200 bil e.g. Microsoft
Mega Caps are few and far between with market caps exceeding $200 bil i.e. Exxon
For Singapore Listed Stocks, FTSE has the following definitions
Straits Times Index – Top 30 companies on SGX Mainboard, generally have market cap > $1 bil, also known as blue chips e.g. SingTel
Mid Caps – The next 50 companies in the SGX Mainboard after STI e.g. M1
Small Caps – Companies within top 98% of SGX Mainboard, but not large enough to be in STI or Mid Cap i.e. OSIM
For Malaysian Listed Stocks, FTSE has the following definitions
KLCI – Top 30 companies on Bursa Malaysia, generally have market cap > RM 1 bil, also known as blue chips e.g. Maybank
Mid Caps – The next 70 companies on Bursa Malaysia after KLCI e.g. Kencana Petroleum
Small Caps – Companies within top 98% of Bursa Malaysia excluding the Top 100 e.g. Axis REIT
Basic Differences Between The Market Caps
There are some basic differences between the larger cap companies and the smaller cap companies. Smaller cap companies tend to exhibit higher growth characteristics, while the larger cap companies tend to be relatively stable. However, smaller cap companies tend to also have higher risk levels than larger cap companies. Over the long run, most Small Cap Indexes tend to outperform Larger Cap Indexes in absolute returns. However, the smaller caps also exhibit larger volatility in both prices and earnings.
Many Small Cap companies also have less research and news coverage, as such, many value investors like to comb through Small Caps and Micro Caps in hope of finding a highly undervalued stock which not many know about. Mid-Large Caps are generally well covered and information is readily available, so they are less likely to be as deeply discounted compared to Smaller Caps.
Given the small market capitalization, Micro Caps and Small Caps share prices are also easier to be subject to market manipulation. It may only take some rumors and a few funds going in to move the share prices significantly. However, such large price appreciations are rarely sustainable and will usually collapse once the market manipulators have taken their profits.
Another main concern with Smaller Caps are that they tend to be less liquid compared to the Larger Caps and you may incur higher bid-ask spreads. It is therefore tougher for larger funds to enter and exit quickly given the small share base as they usually deploy large amounts of capital in a single trade.
From a Portfolio Allocation Perspective
It may make sense to allocate your portfolio with different categories of market cap to capture the different risk and reward characteristics. Micro and Small caps with higher returns but higher risks, Large Caps with stable returns, lower risks and Medium Caps which are in between. Depending on your risk profile and financial goals, you can also tweak the allocation to better achieve your desired investment goals.
It is important though not to confuse market capitalization with growth. Some Large Caps may have high growth as well, while some Small Caps may even have declining growth.
So the classification we will look at in the next post is Growth Level / Maturity Level. Stay tuned!
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