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One size doesn’t fit all – Large cap, mid cap and small cap stocks

This article talks about the categorization of stocks into large cap, mid cap and small caps. It also describes the characteristics of each class, and guides readers about investing in each.

 

In the financial press and on business TV channels, we often hear terms like market capitalization (market cap), and also references to companies as large cap, mid cap or small cap.

Let’s understand what these terms mean, and what each class of stocks has to offer you.

 

Market Capitalization or Market Cap

It is the value of a company as determined by the stock markets.

Each company issues shares, and the total number of issued shares represents 100% ownership interest in the company. Thus, if we know the number of issued shares for a company, and the price for each share, we can derive the value of the entire company.

The value of a company determined in this manner is called its Market Cap.

Market Capitalization of a company = Market price of its shares * Number of shares issued

The price of a stock determined in a free market, where it is determined by market forces of demand and supply, is the most accurate price which is democratically arrived at. Since market cap calculation uses this price, the market cap of a company is the best measure to gauge the size of a company.

Companies traded in the stock market are classified based on their market cap, as each class demonstrates distinct shared traits. Let’s look at the classification of companies based on their market cap.

 

Large Cap

There is no standard definition of Large Cap, and it varies from institution to institution. But as a general rule, if a company has a market capitalization of more than Rs. 5000 Crores, it is considered as a Large Cap.

A Large Cap company is normally a dominating player in its industry, and has a stable growth rate.

It should be noted that almost all the Large Cap companies from India would be considered as Mid Cap or Small Cap companies in a global scenario, as globally, companies are usually classified as Large Cap if their market cap is more than $10 Billion (roughly Rs. 39,000 Crores).

 

Mid Cap

The definition of Mid Cap is hazy, and it varies from institution to institution. But as a general rule, if a company has a market capitalization of between Rs. 1000 Crores and Rs. 5000 Crores, it is considered as a Mid Cap.

A Mid Cap company is normally an emerging player in its industry. Such a company has a potential to grow fast and become a leader (a Large Cap) in the future.

Mid cap companies can show very high growth rates (in percentage terms), because they have a small base – since their size is small, even a small incremental increase in revenue / profits can be a big figure when expressed in terms of percentage.

 

Small Cap

Like Large Cap and Mid Cap companies, the definition of Small Cap is also not concrete, and varies from institution to institution. But as a general rule, if a company has a market capitalization of less than Rs. 1000 Crores, it is considered as a Small Cap.

A Small Cap company is normally a company that is just starting out in its industry, and has moderate to very high growth rate. Such a company has a potential to grow fast and become a Mid Cap in the future.

 

Points to Consider While Investing

Large Cap

People having less tolerance for risk should invest in large cap companies, as they are established companies with a known and more-or-less predictable track record. People investing in stocks for not a very long term should also invest in these companies, as their stock prices
are not very volatile.

Mid Cap

People having a reasonable tolerance for risk should invest in mid cap companies, as these are emerging companies and carry a risk of not becoming leaders. If chosen correctly, mid cap companies can give phenomenal returns when they grow and become industry leaders. (A prime example is Infosys Technologies)

But picking up the right mid cap company requires a lot research and expertise. Therefore, it is advisable to invest in mid caps through mutual funds (MFs).

Also, a mid cap company can take years to really bloom and grow into a large company. So, only people investing for a considerably long term should invest in mid cap stocks.

Small Cap

Only people having a high risk appetite should consider investment in these companies – these companies are in the very initial stages in their life cycle, and there is usually a very high degree of unpredictability concerning their growth.

Small cap companies can take even more time to grow compared to mid caps, but can give exceptional returns if chosen well.

Investment in small cap companies is advisable through mutual funds (MFs) only – direct investment would be only a shade better than speculation!

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