What Are Small Caps? Definition and Key Characteristics

Small capitalization, or “small cap,” refers to companies with a relatively modest total value of their outstanding shares in the stock market. Market capitalization serves as a straightforward metric for classifying companies by size, which in turn provides insights into their operational scale and market influence.

Defining Small Cap Companies

Market capitalization is calculated by multiplying a company’s current share price by its total number of outstanding shares. This figure represents the company’s total estimated valuation in the market. For instance, a company with 1 million shares trading at $10 per share would have a market capitalization of $10 million.

Small-cap companies generally have a market capitalization ranging from $300 million to $2 billion. This range helps differentiate them from micro-cap companies, which typically fall below $300 million, and mid-cap companies, which usually range from $2 billion to $10 billion.

Key Characteristics of Small Cap Investments

Small-cap companies often exhibit a notable potential for rapid growth, primarily because they are in earlier stages of development or operate within specialized market niches. This growth potential is a primary draw for investors, as these companies have more room to expand their operations and market share compared to larger, more established firms.

However, small-cap stocks tend to be more volatile than their larger counterparts. This increased volatility stems from factors such as less diversified revenue streams and a greater sensitivity to economic shifts. Additionally, the stocks of these companies may have lower trading volumes, which can result in lower liquidity in the market.

Another characteristic is that small-cap companies frequently receive less attention from financial analysts. This reduced coverage can sometimes mean that promising opportunities within the small-cap segment might be overlooked by the broader market. Furthermore, smaller companies can be more susceptible to economic downturns or benefit more significantly from economic upturns, making their performance closely tied to the overall economic cycle.

Small Cap Indices and Funds

Small-cap companies are commonly tracked through specialized stock market indices, which serve as benchmarks for the performance of this market segment. Prominent examples include the Russell 2000 Index and the S&P SmallCap 600. The Russell 2000, managed by FTSE Russell, tracks approximately 2,000 of the smallest companies within the broader Russell 3000 Index. The S&P SmallCap 600, established by S&P Global Ratings, focuses on around 600 small-cap American stocks and uses a capitalization-weighted approach.

Investors often gain exposure to small-cap companies through dedicated investment vehicles like mutual funds and Exchange Traded Funds (ETFs). These funds pool money from multiple investors to buy a diversified portfolio of small-cap stocks. Investing through such funds allows for diversified exposure to the small-cap segment without the need to research and select individual companies.