Achieving the highest return possible is the primary goal of every investor. Whether it is a new trader just exploring the world of online trading or an experienced trader looking to diversify even more, understanding the types of stocks available is vitally important to building a successful and stable investment portfolio.
One of the key elements to understand about stocks is their market capitalisation. Market capitalisation generally refers to the estimated value of a company’s stock on the market, calculated by taking the price of a share of stock and multiplying it by the number of outstanding stock shares in the company. Market capitalisation is used to classify different stocks into categories based on their originating company’s value. Companies may be divided into one of several different categories, though those most commonly seen within an investment portfolio will be small-cap companies and large-cap companies.
Stocks with a relatively small market capitalisation, usually between $300 million and $2 billion, are known as “small-cap stocks.” The majority of companies, including now giant global companies such as Wal-Mart, began as small-cap companies. Investing in the small-cap segment of the stock market can be quite risky, since smaller companies are generally more volatile than larger, more established companies. Smaller companies often do not have the financial resources to survive an economic downturn and, together with a product line that is either untested or simply limited in scope, small-caps can be subject to dramatic price swings.
That said, small-cap stocks do have some advantages: the potential for earnings growth can be larger with small-cap stocks, since smaller-sized companies can often increase their profits at a more rapid rate than a larger company. Small-cap stocks are often undervalued; their low-key position compared to larger companies means that analysts frequently do not price the stock in proportion to its intrinsic value, making small-cap markets an ideal place to find lower priced stocks with good earning potential.
Small-cap stocks offer tremendous potential for increasing capital if an individual investor’s portfolio can weather the volatility. Slightly more timid investors can still take advantage of the benefits of small-caps by investing in a small-cap mutual fund.
Some good examples of small-cap companies whose stock is doing well include Ancestry.com and Buffalo Wild Wings.
Large-cap companies are also known as “big-cap” or “blue chip” companies. These companies are global powerhouses that drive not only domestic markets but international markets as well, and include significant names such as Microsoft, General Electric and, of course, Wal-Mart. With market capitalisation values in excess of $10 billion, these stocks are a reliable addition to any portfolio. Many more conservative investors, as well as those seeking to invest as a future source of income, will find these stocks attractive. They are usually quite pricey, but are a reliable part of any well-balanced investment portfolio.
With all the stability, however, comes a downside. Large-cap stocks typically have a much lower rate of return than small-cap stocks. Larger companies have less growth potential than smaller companies, so while an investor has less chance of losing money in a large-cap, they will see a low growth rate.
Large-cap companies also offer less ownership power than small-cap stocks. When stock is purchased in a company, the buyer essentially becomes a part-owner. With a large-cap company, this purchase is a mere drop in the bucket compared to the total number of investors in the company; the ability to influence the company is all but eliminated with large-cap stock.
Beyond the noteworthy companies above, other large-cap companies include Citigroup, Inc., Bank of America Corp., Philip Morris International Inc., Oracle Corp. and The Coca-Cola Company.
Mid-caps, micro-caps and nano-caps
Mid-cap stocks fall in between small- and large-cap stocks, with market capitalisation falling roughly between $2 billion and $10 billion. Mid-cap companies are mid-sized, offering a decreased risk compared to small-caps, while offering a greater growth potential than that of large-cap companies.
Micro-caps and nano-caps have market capitalisation less than $50 million and as such tend to be more high risk than the aforementioned cap stocks.
To be successful as an investor it is vitally important to have a well-balanced and diverse portfolio of investments. Any well-balanced portfolio is going to have a combination of different investments, and among them will be “cap stocks.” A mixture of reliable large-cap stocks, higher-yield mid-caps and volatile small-cap stocks will enable the investor to have steady growth, with the occasional growth burst courtesy of the mid- and small-cap stocks, while protecting a good portion of the investment from market downturns.