Stocks on the Australian share market are categorised by their size. This is usually measured by a company’s market capitalisation. It is calculated by multiplying the company’s current share price by the total amount of shares on issue. A market cap is essentially what the market values the company at. The size of a company has a huge impact on the characteristics of the stock. Knowing the difference between these types of companies will assist the investor to select the stock which is the most suitable for their needs.
A large cap stock is classified as a company which has a market capitalisation of more than $10 billion. Large cap or blue chip stocks are the largest companies on the Australian stock exchange. These companies have generally been around for a long time and are considered stable companies. They usually offer a dividend as their businesses are well established and have consistent cash flows.
Mid-cap stocks have a market cap ranging from $2 billion to $10 billion. These stocks are expected to generate rapid growth. Investing in mid-cap stocks means you are investing in established businesses that have usually not been around as long as large cap companies.
Small cap stocks are usually companies that are younger. They are generally looking to grow their businesses at an accelerated rate. Small cap companies have a market cap between $300 million and $2 billion and are often categorised as growth stocks.
Large Cap – These are stable companies, so they usually offer dividends because of their strong earnings. They are considered less risky and have high liquidity in the stock market. They have less volatility in their stock price.
Mid Cap – These companies offer a hybrid of growth and stability. They offer more capital upside that large cap stocks and but less risk than small cap stocks. Mid cap firms historically grow their earnings faster than small and large cap firms.
Small Cap – These are business in the growth phase so there is higher potential for capital growth. Small cap companies usually focus on domestic business so they are less affected by conflict of international trade.
Large Cap – These companies are mature businesses so these stocks do not experience as much capital growth as small caps. Hence investor will, on average, not see as much stock price appreciation as small cap stocks.
Mid Cap – As these businesses are established, investors will see less capital appreciation in these stocks compared to small caps. These firms are not as stable as large cap firms as they do not have as much capital.
Small Cap – As these businesses are in the growth phase, they may reinvest funds from earnings and not pay dividends to investors. There is also less liquidity in the stock market for small caps. Share prices of small cap stocks experience high volatility. This could lead to stock prices falling harder in bear markets. There is more risk in investing in small caps as companies are newer and are less established businesses. Small cap stocks are also reliant on external capital as their capital is limited.
Investors who are looking for income to fund their living costs who are no longer working will find large cap stocks suitable. This is due to their stable and safe characteristics. These stocks usually pay a dividend.
Investors who are looking for capital growth who can take on risk would find small caps suitable. These investors may not need income immediately so can sacrifice income for capital growth. They also have a long investing time horizon to ride out the stock price fluctuations.
For the investor who is looking for a capital gain with less risk than a small cap, then a mid cap stock selection would be most appropriate. There are mid cap stocks which also pay dividends.
Best time to buy
Small caps rise faster than large caps in bull markets. However small caps fall harder than large caps in bear markets. Large caps are more popular in bear markets as investors look for safe and stable investments. Mid cap companies do well in the expansion phase of the business cycle. This is when interest rates are still cheap.
Lauren Hua is a private client adviser at Fairmont Equities.
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