Stocks on the Australian share market are categorised by their market capitalisation – small, mid, or large cap. This is calculated by multiplying the company’s current share price by the total amount of shares on issue. Small, mid and large cap stocks perform best in different economic environments.
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.
Large caps are more popular in bear markets as investors look for safe and stable investments. Investors will see that large caps will be the fastest to recover after a sell off. One of reasons is that they have been the least impacted during a sell off. During volatile times, when there is uncertainty, investors will look to safer investments such as large caps. As these companies have been around for longer periods, they have more cash reserves during fragile economic times so investors feel more confident investing in these stocks.
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.
Mid cap companies do well in the expansion phase of the business cycle. This is when interest rates are still cheap. Mid caps perform better than large caps when the economy is revitalizing.
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.
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Small caps rise faster than large caps in bull markets. However small caps fall harder than large caps in bear markets. In market sell offs, small caps are the first to go as investors see these as riskier. Investors will see a lack of liquidity in small caps stock when there is a sell off. There will be a lot of sellers and not a lot of buyers which will drive the price down further. During recessionary periods, these are out of favour with investors and may go through a period of underperformance compared to larger cap stocks. Small caps do not do well in high interest rates environment as these companies use debt to grow their businesses and higher interest rates may make it more challenging to service these loans. When the economy is strong and there are higher levels of consumer confidence, small caps do well as people spend money with less constraints.
Lauren Hua is a private client adviser at Fairmont Equities.
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