Difference Between Large, Medium, and Small-Cap in Share Market

 

When beginners enter the stock market, they often have questions about which stocks to invest in. Such questions can overwhelm even a seasoned investor. Stock market investors must have sufficient knowledge to determine which stocks are the right choice for their investment strategy. If you have no clue about which stocks you should put money in, you could face losses. The share market has inherent risk and this risk varies from one stock to another.

Stocks in the stock market are often classified based on their market capitalisation (or market cap) as large-cap, mid-cap, and small-cap stocks. This categorisation helps investors to make informed investment decisions. This article will help you to understand the differences between large-cap, mid-cap, and small-cap stocks.

Let us first learn about the meaning of market capitalisation and its categories in detail.

MARKET CAPITALISATION: MEANING AND CATEGORIES

Market capitalisation refers to the total number of outstanding shares of a company in the market multiplied by the current price of each share. It is a measure of the estimated valuation of a company.

To make things simpler, let us consider the meaning of market capitalisation with the help of an example. Suppose that ABC Company has 20,000 outstanding shares in the market and each share of ABC Company is priced at Rs 20. Then, the market capitalisation of ABC Company will be calculated as follows:

Outstanding shares x price per share

20,000 x 20 = Rs 4,00,000

Therefore, the market capitalisation of ABC Company is Rs 4,00,000.

The companies that are traded on the stock exchanges can be categorised into three broad categories: large-cap, mid-cap, and small-cap. Let us learn about each of them in detail.

WHAT ARE LARGE-CAP STOCKS?

Large-cap companies are businesses that are well-established and have a significant market share. Large-cap companies have market caps of Rs 20,000 crore or more. These companies dominate the industry and are very stable. They hold themselves well in times of recession or during any other negative event. Besides, they will usually have been functioning for decades and have good reputations. If you want to invest in a company’s stocks by taking less risk, then large-cap stocks are a good option. These stocks are less volatile in comparison to mid-cap and small-cap stocks. The lower volatility makes them less risky.

Reliance Industries and Infosys are examples of some large-cap market companies that are listed on the stock exchanges of India. Their strong foothold in the market and consistent good performance makes them good choices for long-term investors.

WHAT ARE MID-CAP STOCKS?

Mid-cap companies are companies whose market cap is above Rs 5,000 crore but less than Rs 20,000 crore. Investing in these companies can be riskier than investing in large-cap market companies. This is because mid-caps tend to be more volatile. On the other hand, mid-cap companies also have the ability to turn into large-cap companies in the long run. These companies offer a higher growth potential than do large-cap stocks, and hence more investors are attracted to investing in such companies.

Metropolis Healthcare, Castrol India, and LIC Housing Finance are some examples of mid-cap companies that are listed on the stock exchanges of India.

WHAT ARE SMALL-CAP STOCKS?

Small-cap companies are those that have a market capitalisation of less than Rs 5,000 crore. These companies are relatively smaller in size and have significant growth potential. What makes them risky is the low probability that they will be successful over time. This makes the stocks of such companies volatile in nature. Small-cap companies have a long history of underperformance but when an economy is emerging out of a recession, small-cap stocks often prove to be outperformers.

Hindustan Zinc, DB Corp, KNR Constructions, and Hathway Cable are some examples of small-cap market companies that are listed on the stock exchanges of India.

DIFFERENCE BETWEEN LARGE-CAP, MEDIUM-CAP, AND SMALL-CAP COMPANIES

·         Company type and stature: Large-cap companies are companies that are big and well-established in the equity market. These companies have reliable management and rank among the top 100 companies in the country. Mid-cap companies sit somewhere between large-cap and small-cap companies. These companies are compact and rank among the top 100–250 companies in the country. Finally, small-cap companies are much smaller in size and have the potential to grow rapidly.

·         Market capitalisation: Large-cap companies have a market cap of Rs 20,000 crore or more. Meanwhile, the market cap of mid-cap companies is between Rs 5,000 crore and less than Rs 20,000 crore. Small-cap companies have a market cap of below Rs 5,000 crore.

·         Volatility: Your investment risk in the stock market is closely related to volatility. If the price of a stock remains reasonably stable even in turbulent markets, it means the stock has low volatility. On the other hand, stocks that see significant price fluctuations at such times are termed as highly volatile. The stocks of large-cap companies tend to be less volatile, which means their prices remain relatively stable even amid turbulence. This makes them relatively low-risk investment options. Mid-cap stocks are slightly more volatile than large-cap stocks and carry somewhat more risk. Small-cap companies are highly volatile and their prices can swing considerably, which increases the risk for investors.

·         Growth potential: The growth potential of large-cap stocks is lower than that of mid- and small-cap stocks. That being said, large-cap stocks are a stable investment option, especially if you have a longer investment horizon. This makes large-caps well suited to investors with low risk appetites. If your risk appetite is moderate, you could look into mid-caps, as these have a slightly higher potential for growth. The highest growth potential lies with small-cap stocks, but you should invest in these only if you have a high tolerance for risk.

·         Liquidity: The term ‘liquidity’ means that investors can buy or sell large-cap shares quickly and easily without affecting the share price. Now, large-cap stocks tend to have higher liquidity as there is a high demand for large-cap shares in the stock market. Thus, squaring off positions is easier when you purchase such shares. In comparison, mid-cap companies have lower liquidity as the demand for their stocks is slightly lower. Small-cap companies have the least liquidity, which can make squaring off positions more difficult.

MUTUAL FUNDS AND MARKET CAPITALISATION

Mutual funds are an integral part of the Indian financial system. Mutual fund schemes are categorised into large-cap, mid-cap, or small-cap funds based on their investment allocation. For example, a large-cap mutual fund scheme will mainly invest in large-cap stock, while mid-cap and small-cap schemes will invest in mid-cap and small-cap stocks, respectively.

How do you choose the right mutual fund scheme for your investment portfolio? A part of your decision-making will depend on your tolerance for risk. Large-cap funds will generally be the less risky option, whereas small-cap funds could carry a higher potential for growth. But before you start looking into such mutual fund schemes, it is important to understand the differences between them in terms of risk.

DIFFERENCES BETWEEN LARGE-CAP, MID-CAP, SMALL-CAP FUNDS IN TERMS OF RISK

·         Risk in Large-Cap Funds

Large-cap funds invest mainly in blue-chip companies. Such funds inherently have certain advantages: The companies they invest in are large and stable businesses with the capability to weather market volatility. There is a high demand for these stocks, which makes them highly liquid. Their growth potential may be low, but so is the risk. And these funds generally bring modest but consistent returns over the long term.

·         Risk in Mid-Cap Funds

These mutual funds invest mainly in mid-cap stocks. This brings a slightly higher potential for growth, and thus the possibility of relatively higher mutual fund returns. However, the possibility of risk is higher as mid-cap companies are less able to cope with market volatility than are large-caps. The goal for the fund manager is to allocate funds to mid-cap companies that could be successful in future.

·         Risk in Small-Cap Funds

The investment focus of these mutual funds is on small-cap companies. The risk exposure is higher with these funds, as small-cap companies are not well-established businesses. They may struggle to stay afloat during a recession, for example. But when a small-cap does well, the possibility of growth is higher than for mid-caps and large-caps. Small-cap funds try to tap into this possibility. Despite the higher risk, there is a possibility of relatively higher returns.

ROLE OF MARKET CAPITALISATION IN YOUR PORTFOLIO

Market capitalisation can play a significant role in your investment portfolio. As the share market passes through different phases, the performance of large-, mid-, and small-cap stocks keeps changing. When large-caps are not doing well, mid- and small-caps could be on the rise. And when mid- or small-caps are plummeting, the large-caps in your portfolio could steady your overall returns. So, it is important for stock and mutual fund investors to diversify their portfolio by investing across market caps. It will help your portfolio to tide you over changing market conditions.

Just make sure to factor in your financial goals, appetite for risk, and investment horizon before investing. Also, keep in mind that investing in the share market or in mutual funds requires research and analysis. If you lack knowledge or need support, it may help to open an account with a large broker like Kotak Securities. This will bring you access to market research and analysis, along with a wide range of educational resources.