How Market Capitalisation Affects Investment Choices

The first-time investor in the equity markets often gets confronted with the terms like small-cap, medium cap, and large-cap stocks. They do not know what these terms exactly mean and what their relevance is to stock market investing. Let us attempt to understand different categories of such companies.   

Company types and stature: Large-cap companies, as the name suggests, are the ones that are big and well-established in the equity market. They have reliable management and rank among the top 100 companies in the country. Mid-cap companies sit somewhere between large-cap and small-cap companies. These companies are compact and rank among the top 100–250 companies in the country. Finally, small-cap companies are much smaller in size and have the potential to grow rapidly.

Market Capitalisation: Large-cap companies have a market cap of Rs 20,000 crore or more. The market cap of mid-cap companies is between Rs 5,000 crore and Rs 20,000 crore. Small-cap companies have a market cap of below Rs 5,000 crore.

Volatility: Your investment risk in the stock market is closely related to volatility. If the price of the stock remains reasonably stable even in turbulent markets, it means the stock has low volatility. On the other hand, stocks that see significant price fluctuations at such times are termed as highly volatile. The stocks of large-cap companies tend to be less volatile, which means their prices remain relatively stable even amid turbulence. This makes them relatively low-risk investment options. Mid-cap stocks are slightly more volatile than large-cap stocks and carry somewhat more risk. Small-cap companies are highly volatile and their prices can swing considerably, which increases the risk for investors.

Growth Potential: The growth potential of large-cap stocks is lower than that of mid-and small-cap stocks. That being said, large-cap stocks are a stable investment option, especially if you have a longer investment horizon. This makes large caps well suited to investors with low-risk appetites. If your risk appetite is moderate, you could look into mid-caps, as these have a slightly higher potential for growth. The highest growth potential lies with small-cap stocks, but you should invest in these only if you have a high tolerance for risk.

Liquidity: The term ‘liquidity’ means that investors can buy or sell large-cap shares quickly and easily without affecting the share price. Now, large-cap stocks tend to have higher liquidity as there is a high demand for large-cap shares in the stock market. Thus, squaring off positions is easier when you purchase such shares. In comparison, mid-cap companies have lower liquidity as the demand for their stocks is slightly lower. Small-cap companies have the least liquidity, which can make squaring off positions more difficult.

One should take into consideration the above-mentioned characteristics of the companies along with other checkpoints before taking an informed investment decision.