What Are Small Cap Stocks? A Definition for Investors

Stocks represent ownership stakes in publicly traded companies, offering individuals a way to participate in business growth and success. The stock market categorizes these companies in different ways, including by market capitalization. This classification system helps investors understand a company’s size relative to others and provides a framework for evaluating their characteristics and potential.

Understanding Market Capitalization

Market capitalization, often shortened to market cap, is a fundamental metric used to determine a company’s total market value. It reflects the aggregate worth of a company’s outstanding shares in the stock market. Calculating market capitalization involves a straightforward multiplication: the current share price of a company’s stock is multiplied by its total number of outstanding shares. For instance, if a company has 100 million shares outstanding and each share trades at $50, its market capitalization would be $5 billion.

Market capitalization is distinct from the individual share price. A company with a high share price might have a lower market cap than a company with a lower share price if the latter has a significantly greater number of shares outstanding. Market capitalization serves as a primary tool for classifying companies into different size segments within the broader stock market.

Defining Small Cap Stocks

Small cap stocks refer to shares of publicly traded companies that possess a relatively modest market capitalization. The generally accepted range for a small cap company is between $300 million and $2 billion, though minor variations can exist. The term “small” in small cap pertains to the company’s total market value, not its physical size, number of employees, or operational scale.

This market capitalization threshold helps distinguish these companies from their larger counterparts, such as mid-cap or large-cap firms. For example, mid-cap companies usually have market capitalizations between $2 billion and $10 billion, while large-cap companies are those with market capitalizations of $10 billion or more. The classification of a company into the small cap category is solely based on this financial valuation metric.

Typical Attributes of Small Cap Companies

Companies classified as small cap often exhibit particular characteristics related to their operational structure and market position. They are frequently younger or less established businesses compared to larger corporations, often with a shorter track record of financial performance.

Small cap companies might also operate within more specialized or niche markets. Their revenue bases are generally smaller than those of large, diversified firms, and they may have fewer financial resources. Furthermore, these companies often have a less diversified product or service offering compared to their larger, more mature counterparts.

Small Cap Market Indexes

Small cap stocks are collectively tracked and measured through specific market indexes, which serve as benchmarks for this segment of the market. The Russell 2000 Index is a widely recognized benchmark for small cap companies in the United States. It includes approximately 2,000 small cap companies and is a component of the broader Russell 3000 Index. This index is managed by FTSE Russell and is commonly used by mutual funds to gauge small cap performance.

Another significant index is the S&P SmallCap 600, maintained by S&P Global Ratings. This index aims to represent the small cap segment of the U.S. equity market by including 600 companies that meet specific liquidity and financial viability criteria. While the Russell 2000 has broader inclusion criteria, the S&P SmallCap 600 typically includes companies with a slightly different market capitalization range for addition. These indexes are important tools for investors seeking to understand the collective performance of small cap companies.