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Small Cap, Mid Cap and Large Cap stocks - what's the difference?

by , 30 October 2019
Small Cap, Mid Cap and Large Cap stocks - what's the difference?
So you've heard the terms bandied about.

Small Cap, Mid Cap and Big Cap stocks.

What does this mean - and how do stocks get labelled as either a small or mid cap for instance?

It is important to know the differences between these different categories of shares - as it will affect your investment strategy…
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How shares are divided in these different categories
 
The “Cap” in small, mid and large cap shares is an abbreviation of ‘capitalisation.
 
That refers to the market capitalisation of the company.
 
So market capitalisation is the value of all of the shares held by investors in a company.
 
On the JSE large cap shares are typically accepted as all of the shares that fall within the Top 40 index. That means the 40 largest stocks on the JSE. It could also be seen as shares with a value of R10 billion or more. This would include shares like Vodacom, Mondi, Absa, BHP Group etc. You could invest directly in a basket of these shares through an ETF like Satrix Top 40 fund.
 
The JSE defines mid cap shares as all shares that fall within the Top 100 shares, and outside of the Top 40 shares. It could also be seen as shares with market values of more than R1 billion but less than R10 billion. This would include companies like Clicks, Foschini, Spar, Tiger Brands and Life Healthcare Group. You could invest in a basket of these shares with an ETF like the Satrix Mid Cap fund.
 
So that leaves Small Caps. On the JSE this would be all shares outside of the Top 100. There are other definitions that could be followed here as well, typically small caps have market values of R1 billion or less.
  
Large and Midcap stocks – what you need to know
 
Large-cap stocks tend to be less volatile during rough markets as investors fly to quality and stability and become more risk-averse.
 
There is a definite advantage for large caps in terms of liquidity and research coverage. Large-cap (and mid-cap) companies have a strong following, and there are lots of research, company financials, and market data available for investors to review.
 
Additionally, they tend to operate with more market efficiency—trading at prices that reflect the underlying company—also, they trade at higher volumes than their smaller cousins.
 
The reason is simply because they are so much larger, there are more shares to trade out there and big funds with billions of rands can actually invest meaningful amounts in them.
 
The JSE Top 40 index is usually used as the benchmark for investment performance in SA because of its relative stability and long term growth. That doesn’t mean that its performance is the best though – in fact it’s far from it.
 
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Small Cap stocks, what you need to know
 
Small cap stocks have fewer publicly-traded shares than mid or large-cap companies. We’re often talking about R400 million businesses here – compared to a massive company like BHP Group at R647 billion.
 
As mentioned earlier, these businesses are typically valued at less than R1 billion or R2 billion.
 
This means these stocks may be thinly traded and it may take longer for their transactions to finalize – whereas with large cap stocks it basically happens instantaneously.
 
That said, the small-cap marketplace is one place where the individual investor has an advantage over institutional investors. Since they buy large blocks of stocks, institutional investors do not involve themselves as frequently in small-cap offerings. If they did, they would find themselves owning controlling portions of these smaller businesses.
 
Because institutional investors aren’t involved in this market, we often find that shares here have very low valuations. But they also have the potential to grow into big cap stocks. It is often easier for a small logistics company to double profit from R200 million a year to R400 million a year than it is for a large cap company to double profit from R50 billion to R100 billion a year.
 
But if there’s one thing you have to always take heed of when investing in small caps it is lack of liquidity. Small cap investors may struggle to offload shares. When there is less liquidity in a marketplace, an investor may find it takes longer to buy or sell a particular holding with little daily trading volume.
 
So, while these shares can form a great part in a diversified portfolio – it is better not to invest in them with money you cannot afford to lose.
 
Here’s to unleashing real value,
Francois Joubert,
Editor, Red Hot Penny Shares
 
P.S: A certain set of ‘spin off’ companies could be about to break up the JSE - Here's how you can profit!


Small Cap, Mid Cap and Large Cap stocks - what's the difference?
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