Saturday, July 02, 2011

Large Cap Stocks vs Small Cap Stocks

Large-cap companies are typically more stable than are small caps, with larger, more diversified revenues and steady, more predictable earnings. That is not to say that many a large cap has not melted down. But the mainstay of large-cap stocks are the blue chips – household names such as AT&T, Coca Cola, ExxonMobil, General Electric, General Motors, IBM, McDonald’s, and Wal-Mart. In addition to providing more predictable, more stable earnings in the stock market today, blue chip stocks often pay dividends.

Not all large caps are blue chips, but large caps are generally considered a less risky investment partly because of their stability and because they have a large float – more outstanding shares – which makes then more liquid than the smaller caps. Large caps also have much broader shareholder base and more significant research coverage.

The concept of the stable, established large cap was challenged during the Internet fever of 1999. New dot-com companies emerged almost overnight with market valuations in the upper half of large-cap stocks. But there was a significant difference. These newly minted large caps had low revenues and, in many cases, no
earnings. The dot-com fallout separated the wheat from the chaff, so to speak. While many traditional large caps lost a great deal of their market value, the dot-com biggies fell 90 percent and more.
There are several indexes that track the performance of large caps. The Dow Jones Industrial Average DJI, which is the most common barometer of the market in general, is made up of 30 large-cap stocks from various industries. The broader S&P 500 SPX is virtually all large caps, and the S&P 100 OEX consists of the largest 100 companies of the S&P 500. The Russell Top 200 Index tracks large-cap stocks with an average market cap of $48 billion.

Mid Caps

Mid caps is a relatively new classification, as we mentioned earlier. These stocks tend to have some of the stability of the large caps but also some of the high-growth prospects of the small caps. Mid caps also have institutional ownership but to a lesser extent than large caps do. Two former high-profile large caps, eBay and Yahoo!, had slipped into the mid-cap segment in the fall of 2001, demonstrating the fluidity of market-cap classifications. eBay was sitting on the cusp, with a market cap of $15.3 billion in early November, so by the time you read this, it may be back in large caps territory. Yahoo! has farther to go, with a current cap of $47 billion.

Small Caps

One of the most enduring characteristics of small-cap stock is their potential for rapid growth. After all, it is easier to double your market value if it is $100 million rather than $100 billion. Reward and risk however, usually go hand in hand, so it is not surprising that small caps tend toward more volatility and higher risk than larger caps do. One obvious reason for this is that the typical small-cap company has a single product line in a single market and is therefore more vulnerable. But small-cap aficionados will argue that a company with a single well-positioned product line can generate explosive earnings growth much more easily than can a company with hundreds of product lines in
dozens of markets.

The shareholder base of small caps if often heavily weighted toward individual investors. Although there are many small-cap mutual funds, many institutional investors stock to large caps and mid caps. Further, many small cap companies have little or no research coverage.

A great majority of small caps are listed on Nasdaq simply because new and smaller companies find a more receptive environment on the Nasdaq than on the New York Stock Exchange. The New York Stock Exchange conducts its business through floor traders, and small companies can get lost without someone to support them and make a market in their stock, which is what the Nasdaq market makers do. Many small-cap stocks have four or five or even a dozen market makers who help them maintain visibility until they can make it on their own reputation. Nevertheless, there are small-cap stocks on the NYSE and AMEX, and large-cap stocks on Nasdaq.

One of the best-known benchmarks of small-cap performance is the Russell 2000 Index. It is made up of 2000 stocks with an average stock market cap of around $530 million as of fall 2001. Another small-cap index is the S&P 600, made up of 600 stocks with a mean market cap of $551 million.

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