Small Cap Stocks vs. Large Cap Stocks: What's the Difference?

Historically, market capitalization, defined as the value of all outstanding shares of a corporation, has an inverse relationship with both risk and return. Large cap corporations, or those with larger market capitalizations of $10 billion and greater, tend to grow more slowly, on average, than mid caps between $2 and $10 billion and small caps between $250 million and $2 billion. Large caps tend to be less volatile during rough markets as investors fly to quality and become more risk-averse.

Lack of liquidity remains a struggle for small caps, especially for investors who take pride in building their portfolios on diversification. Between 2006 and 2015, approximately $6 billion in shares traded on the Russell 2000 compared to greater than $35 billion for the S&P 500 over the same period. This has two effects: small-cap investors may struggle to offload shares, and the managers of small-cap funds close their funds at lower assets under management (AUM) thresholds.

Volatility struck small caps in late 2018, although this is not a new phenomenon. Small cap stocks did well in the first three quarters of 2018, entering September of that year with the Russell 2000 index up 13.4% compared to 8.5% for the S&P 500. Between 1980 and 2015, small caps averaged 11.24% annual growth in the face of rising rates, easily outpacing mid caps at 8.59% and large caps at 8.00%. In the opening weeks of 2019, the Russell 2000 led the market by 7% to the S&P 500’s 3.7%.

[Important: Lack of liquidity remains a struggle for small caps, especially for investors who take pride in building their portfolios on diversification.]

Despite its struggles, the earnings growth for the S&P 500 remains positive for the first quarter of 2019, with earnings outlooks for the end of the year totaling $154.67 per share. The S&P 500 experienced a breadth thrust, in which 85% or more of NYSE stocks advance within a two-week period, in early 2019. This phenomenon usually signals an upswing in the market; in 1987, 2009, 2011, and 2016, it has represented a prime buying opportunity for investors who want to realize gains in the short term. However, in 2008, the breadth thrust was followed by a steep decline in the market some months after its occurrence in late March. Nevertheless, there are reasons to be optimistic when it comes to large caps.

It would actually be more precise to say that there are reasons to be optimistic with large caps relative to other domestic stock sizes. Small caps and mid caps are more affordable than large caps, but volatility in these markets points to large-cap leadership in 2019. Additionally, large caps tend to operate with more market efficiency than smaller segments; there is a decided advantage for large caps in terms of liquidity and research coverage.

What is perhaps most encouraging is the fact that large technology companies cemented their status as valuation and earnings champions, even as domestic markets plodded. As investors look for comfort and quality in 2019, expect large caps to receive an even larger share of attention than normal.

• Large cap corporations, or those with larger market capitalizations of $10 billion and greater, tend to grow more slowly than small caps between $250 million and $2 billion.
• Large caps tend to be less volatile during rough markets as investors fly to quality and become more risk-averse.
• Small caps and mid caps are more affordable than large caps, but volatility in these markets points to large-cap leadership in 2019.