Everything You Need to Know About the Terms Small Caps and Mid-Caps in Stocks

Public companies (organizations listed on the stock exchange) are classified as large, mid, and small caps, where cap stands for capitalization.

This classification is based on their market capitalizations and size. Small and mid-cap stocks have lower market capitalization and free float when compared to large cap stocks.

Understanding market capitalization

Market capitalization is the total value of the company on the stock exchange. It is calculated by multiplying the total number of outstanding shares with the current market price.

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The free float includes those shares that are not available on the stock market for trading under normal circumstances. These are known as strategic or controlling holdings and are not included in free float. Some of these holdings include shares held by founders or promoters, government bodies (as acquirer or promoter), employee welfare trusts, controlling interest holders, and locked-in shares.

Benefits of investing in small and mid-cap companies

1) Higher growth potential

Large companies are established organizations with large market presence. However, such businesses have limited opportunity to grow or release new products in the market primarily because of bureaucracy, the taxes they pay to government and long approval and legal procedure. Therefore, although large cap stocks are safer than small and mid-cap companies, the potential to earn huge returns is limited.

2) Better return on investment

Mid-cap companies are established but still in a growth phase. Such organizations are able to take advantage of newer markets and expand their business. Therefore, you may be able to earn good returns when you invest in stock market in mid-cap companies.Furthermore, small cap businesses have the capability to outperform large companies over a period of time. As these companies expand their business and earn higher profits, you may be able to reap the benefits. Over a period of time, other investors become aware of small companies demonstrating future growth potential. Therefore, the demand for their shares increases, which results in a surge in their prices. This enables you to earn high returns on your investments.

Investing in small and mid-cap stocks

Several investors who are willing to assume higher risks opt for investment in such companies. However, there are certain inherent risks to this type of investment strategy. Here are two such risks

1)  Size

Compared to large cap companies, small and mid-cap organizations are significantly smaller in size. Therefore, there is a higher risk of losing some or all of your investment when you adopt this strategy.

2) Liquidity

Generally, small and mid-cap companies are not traded in as high volumes when compared to large cap organizations. Therefore, you may not be able to easily liquidate your holdings in such stocks, if you need funds urgently.

As an investor, you have the option of investing in one or more of the large, small, and mid-cap companies. However, your decision must be based on your risk profile because small and mid-cap stocks are riskier. You should make an informed decision based on the company’s prospects in the future and its growth potential.

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