What Is a Small-Cap Stock?
Although it may seem less than intuitive, the definition of “small” in the stock market is not at all universally accepted.
There are two ways of defining a “small” company or stock. The first is to look at the company’s revenues for the last four quarters or fiscal year. A small company is one that has revenues below $1 billion. (Some investors consider companies with sales below $100 million to be in a separate category, “micro.” These are generally not appropriate investment candidates for investors seeking high-quality stocks for their portfolios.)
The second way to identify a small stock is by its market capitalization, determined by multiplying the stock’s current share price by the number of shares outstanding. A “small-cap” stock is one with a capitalization below $2 billion. Some investors like to weed out very small stocks and consider those with market caps below $250 or $300 million to be “micro-cap” stocks. Again, these stocks may be too small to warrant serious consideration from many investors.
But these definitions are highly subjective, and different data providers and market commentators may use different defini¬tions or breakpoints.
For example, the Russell 2000 small-cap index includes the 2,000 smallest companies in the Russell 3000, while the Russell 3000 includes the 3,000 largest companies in the U.S. stock market. As a result, the largest company in the Russell 2000 has a market cap of $3.7 billion!
Each year, Russell reconstitutes its indexes to make sure that the included companies represent the true objectives of each index, based not on actual dollar market-cap amounts but on the number of companies in each percentile of size ranges. As a result, the size of “small-cap” companies has increased quite a bit over time. In 1995, Russell defined small-cap stocks as having market caps between $104 and $750 million. In 2011, the range was between $130 million and $2.971 billion.
Stock data providers, such as Standard & Poor’s and Morningstar, have their own methodologies for defining a “small-cap” stock, and these usually differ from Russell’s approach.
Here at the SmallCap Informer, we hope not to get so caught up in the boundaries and categories and definitions of what makes a stock or company “small.” We expect that the vast majority of our stocks will fall into the range of the definitions outlined at the start of this article, but if we occasionally exceed those ranges, we trust that the selections will still be smaller than most of the companies in our subscribers’ portfolios and thus still of interest.