Small Cap (Businesses) - Explained
What is a Small Cap Business?
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Table of ContentsWhat is a Small Cap Firm?How Does a Small Cap Firm Work?Calculating Market Capitalization Investing in Small Cap vs. Large Cap Companies
What is a Small Cap Firm?
Small businesses with low value of market capitalization are categorized as Small Cap firms. A firms outstanding shares in the market make up its market capitalization value. Firms with market capitalization values ranging from $300 million to $2 billion are called as Small Cap firms, but this is by no way a strictly defined range.
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How Does a Small Cap Firm Work?
The Securities and Exchange Commission (SEC) forbids mutual funds from scooping up all the outstanding shares of a Small Cap firm, allowing individual investors to beat institutional investors in acquiring substantial stakes in a Small Cap firm. A mutual funds management would have to file a petition with the SEC to acquire substantial stakes in a Small Cap firm, revealing its hand in the market and driving up share prices. Different brokerages and markets have different measures to categorize Small Cap, Mid Cap, and Large Cap firms. There are no set rules to categorize a firm as either one or other and the range and definition keeps changing.
Calculating Market Capitalization
Multiplying a firms total number of outstanding shares with the current share price gives its market capitalization value. For e.g., Sonic Corp had 48.55 million outstanding shares in June 2016. Its stocks were trading at a per share value of $28.16. Multiplying the two values gives us the total market value of Sonic Corp as $1.37 billion. Based on this number, most brokerage firms would categorize Sonic Corp as a Small Cap firm.
Investing in Small Cap vs. Large Cap Companies
While Small Cap firms offer investors high growth potential, this potential comes at very high risks. Large Cap firms have usually tided over their Small Cap days and although they do not offer exponential growth, they provide stability to investors. Economic trends demonstrate that Small Cap firms outperform Large Cap firms by huge margins in terms of providing returns on investments. But this is speculative and trends vary with changing economic scenarios. For e.g., during the tech boom of the 1990s, Large Cap firms dominated the conversation and capital flow. Post the recession in the early aughts, Small Cap firms enjoyed a much higher degree of success than their Large Cap counterparts. Investors should focus on other more important factors before betting on a firm and also diversify their portfolios with shares in both Small and Large Cap firms, to make the most of the benefits offered by firms in both categories.