The markets (equity) is divided into Large Cap Mid Cap Small Cap. Here the word “Cap” stands for market capitalization. It denotes the size of the company. In mutual funds, this size aspect is recognized as a category. Hence you will find funds like – HDFC Top 200 Fund or PGIM Midcap Opportunities Fund. In this article, we will develop an understanding of what these different categories of stocks are and what are the associated risk-reward attributes.

Equities – Market Capitalization decides Large Cap Mid Cap Small Cap

Once an investor decides to invest in listed equities, one will have to choose from Large Cap stocks, Mid Cap stocks, Small Cap stocks, etc.

Based on the market capitalization of any company which in turn is a calculation done based on the –

current share price * number of outstanding equity shares of the company

for eg – a company stock price is 103 & number of shares are 3 Cr it market cap will Rs (103 X 3 Cr) = 309 Cr

A stock gets classified amongst the 3 categories mentioned above.

The classification of shares into large-cap, mid-cap or small-cap is also made on the basis of the relative size of the market in that particular country. Thus, a mid-cap stock in a developed market may be classified as a large cap stock in an emerging country like India.

What are Large Cap Stocks?

These are Top 100 companies ranked on market capitalization.

Stocks of the largest companies (many blue-chip firms) in the market are classified as large-cap stocks. Being established enterprises, they have at their disposal large reserves of cash to exploit new business opportunities and they are generally the market leaders of their respective sectors.

The sheer volume of large-cap stocks does not let them grow as rapidly as smaller capitalized companies and the smaller stocks tend to outperform them over time.

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Investors, however, gain the advantages of reaping relatively higher dividends compared to small- and mid-cap stocks while also ensuring the long-term preservation of their capital. Most of the large institutions (both domestic & foreign) choose to invest in these companies as they have the largest number of shares outstanding which in turn increases the liquidity of the stock.

Promoters or Management for these stocks has proven themselves already as they are part of a large-cap stock.

Mid Cap Stocks

These are 101 – 500 companies ranked on market capitalization.

Mid-cap stocks are typically stocks of medium-sized companies. These are stocks of well-known companies, recognized as seasoned players in the market, but they are smaller than their large cap counter-parts.

They offer an investor the twin advantages of acquiring stocks with good growth potential as well as the stability of a relatively larger company.

Mid-cap stocks also include emerging blue chips; companies that show steady growth backed by a good track record.

They are like blue-chip stocks (which are large-cap stocks) but lack their size. These stocks tend to grow well over the long term. In the respective sectors, they would be generally the 2nd ranked or 3rd ranked company in terms of fundamentals and business potential.

These companies have relatively less liquidity as compared to large cap stocks and thus the foreign ownership in these stocks is also relatively less. The stock price for these stocks can be volatile in the short term as they have very concentrated holding pattern and majorly lying with the promoter.

Small Cap Stocks

The 501th onwards companies ranked on market capitalization.

The stocks of small companies that have the potential to grow rapidly are reclassified as small-cap stocks. These stocks are the best option for an investor who wishes to generate significant gains in the long run; as long he does not require current dividends and can withstand price volatility in the short to medium term.

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As many of these companies are relatively new, it is difficult to predict how they will perform in the market. Being small enterprises, growth spurts dramatically affect their values and revenues, sending prices soaring.

On the other hand, the stocks of these companies tend to be volatile and may decline dramatically. Most Initial Public Offerings are for small-cap companies, although these days large companies also tend to source the capital markets for expansion plans. Because they have the advantage of being highly growth oriented, small-cap stocks can forego paying dividends to investors, which enables the profits earned to be reinvested for future growth.

The risk of faulty accounting practice and lack of transparency in the financial information is the highest in these companies. Also, the promoters for these companies generally haven’t proven themselves in executing large orders and thus the future prospect is difficult to ascertain.

Any other Capitalizations?

What is Micro Cap? What are Penny Stocks?

Normally shares below the price of Rs 10 are called Penny Stocks or Micro Cap.

These are high-risk stocks as very often they are promoted by the broking community for price rigging.

Due to size, it is easy to buy and dump, so you will find many of these stocks often plus by 5% or minus by 5%. Touching trading circuits is very common.

Normal perception is that these are often candidates of business reversal or a large order or news related to takeover targets or technology upgrade or having a large asset like land.

These companies normally have a bad past (often tainted). They may have name changes or even have changes in business lines.

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and, you know most investors know all this but still, they look for these companies to make a quick buck.

Small cap does not mean all companies are bad. many profitable companies today in large cap or mid cap were small cap once.

The risk in Large Cap Mid Cap Small Cap

The risk rises from Large cap to Small Cap.

The 2 main reason are:

Mid / Small Cap are under-owned. (Small number of investors own them. So they are comparably low on liquidity)
These are also tracked or researched by a small number of experts.