Small Cap Stocks

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Public companies issue their stocks or shares to the general public in order to raise money for growth and expansion. These stocks are then traded on stock exchanges to earn profits driven from the performance of the companies. Generally, there are three categories of stocks in the stock market on the basis of market capitalization (or market cap), which are large cap, mid cap and small cap stocks.

We will discuss all these types at length while penning down most of the focus towards the small-cap stocks.

First let us try to understand what market capitalization means and how it is calculated. Definition wise, Market capitalization is the term used to describe the total market value of a company’s outstanding shares.

Calculation of Market capitalization

The market capitalization is calculated simply by a multiplication of the CMP (Current Market Price) of one share of the company with the total outstanding shares of the company.

Where,

Outstanding shares imply all the currently owned shares by the stockholders, officials of the company and other general public investors. In the total outstanding shares, the shares owned by the company promoters or the owners are not included.

Market Capitalization = (Total no of outstanding share) * (Price of one share)

For example: Let us calculate the market cap of Reliance Industries

Total number of outstanding shares = 633.76 crores

Last Traded Price = ₹1,210.95

Market cap = ₹767,457.71 crores

As such, there is no fixed market capitalization range for classifying stocks into small cap stocks, mid cap stocks and large cap stocks. Bombay stock exchange (BSE) uses the 80-15-5 rule for this classification.

Let us understand what it is and how the classification is done.

  • All the companies are first arranged in descending order of their Market Capitalization.
  • Now, the group of stocks of those companies at the top that together contributes 80% of the total market cap are called Large Cap Stocks.
  • The next group of stocks of companies contributing 15% (80 – 95%) of market cap are called Mid Cap Stocks.
  • Finally, the rest of the stocks of companies which contribute 5% of market cap are called Small Cap Stocks.

Although, the small-cap stocks constitute a very small portion of the total chunk of shares, however, they attract the highest attention from the stock trader community.

Going ahead, let us discuss more characteristic details of small-cap stocks along with the mid-cap and large-cap ones and analyse the pros and cons of investing in each one of them.

Small Cap Stocks

These are the companies generally with market capitalization under ₹2,000 crore. They have smaller revenue and client bases and are usually start-ups or companies in the early stage of development.

But since these companies are relatively new as they are yet to be discovered within the sector, they have a lot of potentials to expand their operations and grow at a very fast pace, thereby generating extremely good returns for their investors.

Since they need capital for growing and expansion purposes, they do not distribute good dividends. Investors who want to gain significant returns on their capital, in the long run, can invest in small-cap stocks when their stock prices are comparatively lower and reap the benefits after a few years when the company has grown and its stock price has soared high.

However, before investing in small stock companies, one must do a thorough research about the company. There is a greater amount of risk in investing in small-cap companies as there are always fears of poor performance due to many factors and even bankruptcy.

A lot of small companies do not have enough financial strength to survive economic downturns and some of them might be mismanaged businesses run by inefficient promoters. One should also keep in mind that the liquidity in these stocks is less.

Top ten small-cap stocks in descending order of their market caps traded on our stock exchanges:

 

Furthermore, as mentioned above, there are other types of stocks other than the small-cap stocks as discussed below:

Mid Cap Stocks

Mid-cap stocks are stocks of mid-sized companies that have a market cap in the range of ₹2000 crore to ₹10000 crore. Mid-cap companies can be considered to be on the border of large cap and small cap companies on both ends of the market capitalization spectrum.

Mid-cap companies are larger than small-cap companies in terms of revenue, profitability, employees, client base, etc.

Mostly these stocks belong to some of the well-known companies. Investing in mid-cap stocks offer twin advantages of buying stocks with excellent growth potential as well as the stability of a larger company. Their dividend payouts are smaller than large-cap stocks.

Liquidity in mid-cap stocks is good and higher as compared to small-cap stocks. The risk in investing in mid-cap stocks is lower as compared to small-cap stocks but greater than large-cap stocks.

Top ten mid-cap stocks in descending order of their market caps traded on our stock exchanges:

 

Large Cap Stocks

Large-cap stocks are of those companies that are large and have well-established businesses. The market caps of these stocks are the highest and go from ₹20,000 crore up to several lakhs or crores.

They have extremely good business strengths and have large reserves of cash to exploit new business opportunities. Their financial health has been consistently good over the past years. They distribute consistent good dividends to their shareholders.

However, since they are so huge already, the chances of exponential growth in them are quite lower as compared to small and mid-cap stocks. Since there are two sides to every coin, it also means that investing in large-cap stocks is quite safe.

In fact, among all the small, mid and large cap stocks, the risk in investing in large-cap stocks is quite low. Liquidity in these stocks and their derivative options is very high.

You know what, let’s dig a bit more into this and talk about the stock type that attracts the lowest risk with a definite return on your investments.

Blue Chip Stocks

Blue chip companies are the largest of large-cap companies. There is no clear-cut definition of blue chip companies. They are very well known leading companies in their respective industry sectors and have a strong track record of paying dividends regularly. Blue chip companies have a long history of strong financial performance.

These are the stocks which are sought after by both domestic and foreign investors.

Some examples of blue-chip companies are ITC, Tata Consultancy Services Ltd. (TCS), Reliance Industries, Oil and Natural Gas Corporation Limited (ONGC), HDFC Bank Ltd.

Top ten large-cap stocks in descending order of their market caps traded on National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are:

 

Conclusion

So, after discussing all the details about small, mid and large cap stocks, we should carefully make a selection of stocks for our portfolio according to our requirements and risk appetite. Some small-cap stocks have the potential to become mid-cap or even large cap in few years time while on the other hand, some small-cap stocks may not be able to survive harsh conditions of the market.

A thorough research about the company and knowledge of economy as a whole will help us make wise investment decisions in small-cap stocks. Mid-cap stocks lie in between large-cap stocks and small-cap stocks in terms of returns and risk. They should be preferred if one wants to gain benefit from their stability as well as growth potential.

If one wants to preserve one’s capital and earn dividend payments consistently, then, large-cap stocks are the ones that should be invested in. Basically, one should make a portfolio of a good mix of all the three small cap, mid cap and large stock caps and the proportion of them can be varied according to the risk one is willing to take and the life stage one is in.

Young professionals earning consistent good incomes may be able to take more risks and invest more in well researched small and mid-cap stocks. On the other hand, retired individuals may find investing in large-cap stocks more meaningful. They do not have to fear to lose their hard-earned capital and can enjoy the benefits of consistent and good dividend incomes.

So, it is recommended that one should be completely clear about one’s expectations of returns and risk before investing in the stock market.

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