Small Cap vs Large Cap Stocks | Risks and Returns Comparison

There are many variables you need to consider when developing your investment strategy in the stock market. One of those variables is evaluating the risks and returns in small cap vs. large cap stocks. Some see small caps as the best investments for growth. Large caps are good for conservative investors.

One of the first categories of screening is the market capitalization, also known as the market cap, of a company. The market cap, in short, is the measure of the size of the company.

The size of a company carries with it risk and return expectations and implications. Once you decide to use stocks in your asset allocation, you need to pick what kind of stocks you will include. It’s important to understand these before you build your investment portfolio.

There are both risk and return implications for the market cap of a company. Before we go into the risks involved in both small cap vs. large cap stocks, let’s first take a look at its potential return on investment. These are just some principles on how to invest in stocks for beginners.

The Small Cap Advantage

When it comes to the return and growth potential of small caps vs. large caps, small cap stocks have the advantage. Here are a few of the main advantages.

• Growth potential
• Shares are cheaper
• Diversification advantage
• More volatility

Growth Potential

Here’s a fact about all large companies like GE, Google, and Microsoft. They were all small cap companies at some point before they became large cap companies.

That’s what we’re looking for in investing in small caps. We are hoping that one day they will become the next Google or Microsoft.

There are also many growth mutual funds out there that use small cap stocks as a way to grow. That might be a good option if you don't have the time to stock pick on such narrow criteria.

Shares Are Cheaper

Shares in small cap companies then to be cheaper than large cap companies. Take Apple (AAPL) for example. They are currently trading at $264.03 per share. Compare that to The Timberland Company (TBL), which is trading at $22.36.

This means that you can buy more shares for less money. So when the stock price goes up, there is a more powerful multiplier effect.

Diversification Advantage

The cheap stock prices also means that you have more room to diversify your portfolio. For one share of Apple, you can buy 10 shares of a small cap stock. This means you can spread your risk around with less trading capital.

Diversification also means that you have a better chance of investing in a future Google.

Investing is a numbers game as much as it is about stock picking. If you invest in five small cap companies, and four of those companies go bankrupt but one turns out to become the next Google, it all becomes worth it.

Beat The Market

Small caps is also an opportunity to beat the market as a whole. Because many small companies have surge for various reasons, over time, many of them have beat the market.

In addition, many large managed funds like mutual funds, don't generally invest in many small cap companies because they are restricted from buying controlling shares in any company without permission. Because of this, you have the opportunity to get into stocks that institutional investors traditionally don't buy.

More Volatility

Small caps tend to be more volatile than large caps. This is a great advantage to those who are stock trading for short term profits, i.e. day traders. This may not be as important for most long-term investors but I thought I’d just throw that in there.

So when looking at the return on investment for small cap vs large cap stocks, the smaller companies have the most potential.

Although small caps generally win out if you want the biggest bang for your buck, large caps win when it comes to level of risk. The bigger they are, the harder they fall. But they are a lot less likely to fall. They are better stocks to buy if you are risk adverse.

An evaluation of risk levels of small cap vs large cap companies will show that larger companies are less likely to fail and less likely to take a huge dive in stock price. In fact, most of them grow steadily over time.

You can almost think of large cap stocks as investing in bonds. The risk level of large cap stocks and bonds are comparable.

Another great cash advantage to large cap stocks is that many times they offer dividends. Dividends are a percentage of earnings that companies sometimes gives back to the shareholder. It's a nice little perk that many large cap companies offer.

Investing Strategy

Small cap stock investment is good for young investors. This allows small companies the chance to grow. It also gives time for the investor to recover should their small cap investments fail.

Large cap stock investment is a good strategy for older investors who need the safety of knowing their money is safe, will offer at least enough growth to beat inflation and that may even offer dividends.