Glossary · Stocks and markets
Small cap
A small-cap stock is a share of a smaller listed company, by a common rule of thumb one worth roughly $300 million to $2 billion on the stock market.
Also called: small-cap stock, small caps, small companies, Russell 2000
In plain words
In a school, the seniors are the big names everyone knows, but the freshmen have the most growing left to do. In the stock market, the freshmen are the small caps: listed companies with a small market value.
The lines are rules of thumb: large caps are worth more than about $10 billion, mid caps $2 billion to $10 billion, small caps about $300 million to $2 billion, and anything smaller is a micro cap. Index makers set their own limits and move them as markets grow.
There are many more small companies than big ones, but together they are worth much less. The best-known US small-cap index is the Russell 2000; S&P has its SmallCap 600.
Example
Why size matters to an index fund
- A small cap worth $1 billion and a giant worth $1 trillion are both in a broad market index.
- In a fund weighted by market value, the giant gets 1,000 times as much money.
- If the small company doubles, a fund holding the whole market barely notices; a small-cap fund feels it.
That is why small caps have their own indexes and funds: in an index of the whole market, weighted by value, they almost disappear.
One level deeper
Small companies can grow faster from a low base, but they are riskier: fewer products, less access to money, more dependence on a few people. Their shares often trade less, so the gap between buying and selling prices is wider and big orders move the price more.
Research by Rolf Banz (1981), and later by Eugene Fama and Kenneth French, found that US small caps had earned more than large caps over long periods: the “size effect”. It has been weak or absent in many decades since it was discovered, and part of it disappears once the tiniest, hardest-to-trade stocks are left out.
Small caps tend to fall harder in a recession and bounce harder in recoveries, because their profits and borrowing costs depend more on the home economy and on interest rates.
Why it matters
They are where tomorrow’s large companies come from, and where most listed companies are, by number.
They behave differently enough from large caps to matter for diversification.
Their performance is a gauge of investors’ appetite for risk and of the home economy, since they earn more of their money at home.
A common mistake
Myth: Small caps always beat large caps over the long run.
In fact: They did in some long periods, not in others. For much of the 2010s and early 2020s US large caps did far better, and the extra return found in older data has been unreliable since.
Questions people ask
What counts as a small-cap stock?
By the common rule of thumb, a company worth roughly $300 million to $2 billion on the stock market. Index makers use their own limits, often higher, which change with the market.
What is the Russell 2000?
The best-known US small-cap index: roughly the 2,000 smallest of the 3,000 largest US listed companies (the Russell 3000), weighted by market value.
Are small caps riskier than large caps?
Usually, yes: their prices swing more, more of them fail, and their shares are harder to trade in large amounts. In exchange, some of them grow much faster.
Read more on BigCapital
About the numbers
- This page explains a term. It is not investment advice.