Globally, more than 8,700 equities are listed on exchanges.i Finding ways to categorise and assess them is a key first step for any equity investor, in our view. One such way: considering company size. In our research of historical market returns, we have found different-sized equities tend to perform better at different times. But what makes a firm’s shares big or small? It might surprise some investors that large shares as defined within the investment industry aren’t necessarily those of companies with the most earnings, sales, storefronts or employees. We think understanding how the investment industry gauges company size can help investors prepare their portfolios for different situations.
When commentators refer to large or small shares, they are usually referring to a firm’s market capitalisation—its share price multiplied by the number of its shares in issuance. The result gives a rough idea of what price a company might fetch if it were for sale. Many investors and data providers sort equities into large-capitalisation (large-cap), mid-capitalisation (mid-cap) or small-capitalisation (small-cap) categories.
Different sources define these categories differently. One common definition: Large-cap shares have market capitalisations of at least £8 billion, mid caps fall between £1.8 billion and £8 billion, and small caps are between £220 million and £1.8 billion.ii Firms with even smaller market capitalisations may be called micro caps, whilst those with extremely large capitalisations—£160 billion or above—are sometimes called mega caps.iii
Other sources apply these terms on a relative basis. In many of its indexes, MSCI, a provider of equity market indexes, ranks firms by market capitalisation. In those cases, equities considered large caps collectively comprise approximately 70% of the index’s total market capitalisation.iv The next-largest firms, accounting for about 15% of the index’s total capitalisation, are mid caps. The smallest firms, accounting for the final 15% or so of the index’s market cap, are dubbed small caps.
At Fisher Investments UK we use slightly different general classifications. First, we consider mega caps those equities with market caps exceeding the world equity market’s weighted average capitalisation—the average adjusted by a factor reflecting each company’s relative size. Entering 2020, that figure was £151.3 billion.v Across the developed world, 33 companies met this standard.vi In our view, large caps currently encompass capitalisations ranging from £44 billion to the mega-cap threshold. Mid caps fall between £8.8 billion and £44 billion, with small caps below £8.8 billion.
Perhaps surprisingly, a company’s market cap does not necessarily correlate with its earnings, sales or number of employees or facilities. For example, Adyen, a Dutch online-payment-platform business, has 1,182 employees. In 2019, it had £2.3 billion in sales and £179 million in net income.vii Autogrill, the Italian restaurant chain, has 62,061 employees. In 2019, it had £4.7 billion in sales and £180 million in net income.viii Yet despite having a fraction of the employees and half the annual sales of Autogrill, Adyen’s market cap dwarfs Autogrill’s, £22.4 billion to £537 million.ix
Why? Market cap gauges a company’s worth. In our view, that usually depends on investor perceptions of the firm’s future earnings potential as well as its current assets and physical capital. Autogrill is in what we consider a slower-growth industry, the restaurant business, whilst Adyen is in the Tech sector—what we deem a higher-growth category. Adyen’s higher market cap indicates investors expect it to be worth much more in the future than Autogrill, in our view.
Our research indicates size can play a significant role in determining which equities fare best at different times. We have found small caps typically tend to outperform larger companies early in bull markets (prolonged periods of generally rising equity markets). In our view, this is because smaller companies often struggle most during the recessions that typically accompany bear markets (prolonged broad equity market declines of -20% or worse with identifiable fundamental causes). We find that small caps often face greater difficulty borrowing and raising capital from banks and investors during such periods. Their small size may create greater risk of financial woe, or even bankruptcy, potentially hurting their shares more than those of larger firms. Shares of smaller firms that survive can then soar when sentiment becomes less dreadful and a new bull market begins, we have found.
From 2009’s global bear market low through that year’s end, for example, world small caps jumped 63.4%, outpacing world large caps’ 46.2% return.x Correspondingly, our research indicates large caps and mega caps historically have tended to improve relative to small caps as bull markets age.xi In our view, investors buying equities later in bull markets tend to be cautious. We think they prefer larger shares of firms with strong brand recognition, perceiving them to be more stable.
Now, we think it is important to note that this trend—smaller shares faring better early in bull markets and larger shares leading later—is becoming increasingly well known amongst investors. Whether the trend continues is thus an open question—in our view, equity prices usually already reflect well-known information. That could impact the relative returns of large and small shares at various market stages going forward, including in the bull market that appears to have begun in late March.
Still, we think understanding equity size classifications and their relation to historical market leadership trends can help investors begin calibrating future expectations—and then assess whether historical trends will continue.
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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
i Source: FactSet, as of 10/07/2020. Constituent count in the MSCI ACWI Investable Market Index, a gauge covering 99% of listed equities from 48 countries worldwide.
ii “Small Cap Stocks vs. Large Cap Stocks: What’s the Difference?,” Sean Ross, Investopedia, 20/03/2020.
iii “Understanding Small Cap and Big Cap Stocks,” Rick Wayman, Investopedia, 13/10/2019.
iv “MSCI Global Investable Market Indexes Methodology,” MSCI, May 2020.
v Source: FactSet, as of 10/01/2020
vi Source: FactSet, as of 31/12/2019. Mega cap is defined as companies larger than the weighted average market cap of the MSCI World Index on 31/12/2019.
vii Source: FactSet, as of 10/07/2020.
x Source: FactSet, as of 09/07/2020. MSCI World Small Cap Index and MSCI World Large Cap Index returns in GBP with net dividends, 09/03/2009–31/12/2009.
xi Source: FactSet and Fama/French Data Library, as of 31/12/2019. Statement based on Fama/French total return data pre-1979 and Russell total return data post-1979. Fama/French deciles are market-cap weighted with small-cap bucket equal weighting deciles 3–6 and large-cap bucket equal weighting deciles 7–10; data is daily total returns.