Investing in the stock market and certain unit trusts would expose you to terms like “small cap”, “mid-cap” and “large cap”. The market cap refers to the total value of all the company’s shares of stock. Take the total number of outstanding shares and multiply it by the price per stock.
Generally speaking, small-cap companies have a market value between USD300 million to USD2 billion. They are often young companies serving niche or emerging markets. On Bursa Malaysia, some small-cap companies are KKB Engineering Berhad, Dayang Enterprise Holdings Berhad, Sedania Innovator Berhad, and Tune Protect Group Berhad.
Large-cap companies are formed with a market value exceeding USD10 billion, known for their reputation in producing quality products, maintaining a steady growth rate, having a history of consistent dividend payments, and steady growth. Examples of large-cap companies in Bursa Malaysia are Malayan Banking Berhad, IHH Healthcare Berhad, Tenaga Nasional Berhad, and CIMB Group Berhad.
In this article, we will learn more about small-cap vs large-cap investment risks!
Small-cap Investment Risks
Small-cap investment has four primary aspects which make them relatively riskier than large-cap ones, which are:
- Less liquidity
The liquidity risk is incurring losses resulting from the inability to meet payment obligations on time. It can also result from being unable to do so at a sustainable cost. This can create an unfortunate situation where investors can’t buy enough shares at the right price even if they want to, or it may not be easy to sell their shares at favourable prices.
- Less access to capital and not as many financial resources as large-caps
Compared to large-cap companies, small-cap companies generally own less access to capital. They also do not have as many financial resources as large-cap companies. This situation results in difficulty for smaller companies to undertake large capital expenditures or obtain financing to support their cash flow.
- Lack of operational history and the potential for its unproven business model
A lack of operational history and the potential for its unproven business model, proves to be a faulty methodology. Smaller companies can be affected by these two factors. These make it more difficult for them to effectively compete with larger companies since they are not as likely to have an established loyal customer base and also more vulnerable to consumer preference changes.
- Insufficient data and information for retail investors to make an informed evaluation
Another primary aspect that makes small-cap potentially riskier than large-cap stocks is data. Commonly, information about small companies available to the public is not as much as what large companies have. Therefore, it is more difficult for potential investors to make an informed evaluation of small-cap stocks.
Large Cap Investment Risks
Meanwhile, some risks of large-cap stocks include:
- Low capital appreciation
Capital appreciation is talking about a rise in a large-cap stock price. The difference between the purchase and selling price of large-cap stocks is low. Therefore, investors may be unable to get the most out of their investment.
- Expensive stock price
Large-cap stocks are expensive, making them unsuitable for some investors who do not have the funds. It can also be risky because high-priced stocks have a chance of going down.
- Sensitive to the movement of institutional investors
The size of larger companies can work against them. For example, reorganizing internally or revamping a larger company’s business models to pivot in another direction could be hard. It can cause a disadvantage for them in the marketplace if they lose some of their competitive edges.
- In the long term, they are often not as agile compared to small-cap companies
Large-cap stocks generally aren’t great for investors looking for a quick buy-and-sell win. This type of stock is better suited for a buy-and-hold strategy, involving buying shares and holding them over time with hopes that their value increases.
Investing is associated with risks. You transfer the earning function to the respective management by purchasing the stock market and unit trust. Understanding the associated risks is crucial, especially regarding your financial goals.