Pros and cons of choosing stocks by market cap
Pros of choosing stocks by market cap
Market capitalisation is commonly used to help inform decisions about which stock to invest in because it gives investors information about the relative size of one company versus another. This is why investors tend to split stocks into categories based on their market capitalisation: large-cap, mid-cap and small-cap.
Large-cap companies typically have a market capitalisation of $10 billion or more, mid-cap companies between $2 billion and $10 billion, and small-cap companies between $300 million and $2 billion. The cut-off values of each category can be vague, and differ from country to country.
Market capitalisation is a simple and relatively effective way to assess risk. Investing in large-cap companies is thought to provide long-term rewards and less risk, as the companies are well established and stable. Mid-cap companies have great growth potential but tend to be riskier than large-cap stocks, although not as risky as small-cap stocks. Small-cap companies are often considered a high-risk investment choice due to factors like their limited financial resources.
Cons of choosing stocks by market cap
Although there can be a variety of benefits of using market capitalisation to identify which stocks to invest in, there are also certain limitations to this method. For instance, a business’s worth (its enterprise value) is not accurately reflected in the market cap – it only reflects equity value. Share prices may be over- or undervalued, because they only reflect how much the market is willing to spend.
