When starting out as an investor, the abundance of investment options can be overwhelming, especially for beginners. Whether you're a seasoned investor or just starting out, understanding where to allocate your funds is paramount to success. Amidst the myriad of choices, one fundamental concept stands out: market capitalization.
This article aims to demystify the complexities surrounding market capitalisation and its implications for investors, focusing specifically on the distinctions between large cap, mid cap, and small cap stocks and mutual funds. By delving into these categories, we'll equip you with the knowledge to navigate the market with confidence and make well-informed investment decisions tailored to your financial goals and risk tolerance.
By exploring these categories, this article will aid you in making investment decisions that align with your risk tolerance and financial goals. Let's start by looking at market capitalisation and then delving deeper into the unique characteristics of large, mid, and small-cap companies.
Market Capitalisation
Before diving into the different classifications, let's establish the foundation – market capitalisation (market cap). Market cap refers to the total market value of a company's outstanding shares. It's calculated by multiplying the current share price by the total number of shares issued by the company. In simpler terms, it represents the company's size and value in the stock market.
Let's take the hypothetical example of 'XYZ' Company, which has 15,000 outstanding shares available in the market, priced at ₹25 per share. To calculate the market capitalization of 'XYZ' Company, we simply multiply the number of outstanding shares by the price per share:
15,000 x ₹25 = ₹3,75,000
Thus, the market capitalization of 'XYZ' Company amounts to ₹3,75,000.
Do Mutual Funds Have Market Capitalisation?
It's important to understand that a mutual fund itself doesn't have a market capitalization. Market cap applies to individual companies, and a mutual fund holds shares of multiple companies within its portfolio.
However, we can look at how a mutual fund's net asset value (NAV) is calculated, which reflects the overall value of the fund's holdings. Here's an example:
Imagine a mutual fund named "Growth Plus" that invests in three companies:
Company A: 100 shares at ₹100 per share (Total value: ₹10,000)
Company B: 50 shares at ₹200 per share (Total value: ₹10,000)
Company C: 200 shares at ₹50 per share (Total value: ₹10,000)
Step 1: Calculate the total value of each holding:
Company A: ₹10,000
Company B: ₹10,000
Company C: ₹10,000
Step 2: Find the total value of all holdings:
Total Value = ₹10,000 (Company A) + ₹10,000 (Company B) + ₹10,000 (Company C) = ₹30,000
Step 3: Divide the total value by the number of outstanding units of the mutual fund:
(Let's assume Growth Plus has 1 million outstanding units)
NAV per unit = ₹30,000 (Total Value) / 1,000,000 (Outstanding Shares) = ₹0.03 per unit
This represents the NAV per unit of the "Growth Plus" mutual fund. The NAV fluctuates daily based on the performance of the underlying companies within the portfolio.
As per SEBI regulations, companies listed on the stock exchange are categorized into large cap, mid cap, and small cap based on their market capitalization, following a standardized approach. Here's how SEBI defines each category:
Large cap: Companies ranked from 1 to 100 by market capitalization.
Mid cap: Companies ranked from 101 to 250 by market capitalization.
Small cap: Companies ranked beyond 250 by market capitalization.
It's important to note that market capitalization is subject to change due to fluctuations in share prices. When a company issues more shares, its market capitalization increases, whereas repurchasing shares reduces it.
Large Cap Stocks
According to SEBI's classification rules, The top 100 companies listed on the stock market, with the highest market value, are known as large-cap companies. Mutual funds that invest in these companies are called 'Large-cap funds'.
Large-cap companies are well-established and usually have a strong track record. They're often referred to as 'blue-chip stocks'. These companies typically have a market value of ₹20,000 crores or more, indicating their significant presence in the market.
Large-cap companies dominate their industries and are known for their stability, even during tough economic times. Many of these companies have been operating for decades and have earned a good reputation. Investing in large-cap stocks is considered less risky compared to mid-cap and small-cap stocks, as they experience less price fluctuation. However, because of their lower risk, the returns on large-cap stocks may not be as high as those on mid-cap and small-cap stocks.
Examples of Large Cap Stocks (As of April 2024): Trent Ltd, Tata Motors Ltd, Nestle India
Mid Cap Stocks
In 2017, SEBI introduced a guideline stating that companies ranked from 101 to 250 based on their market value are termed as mid-cap companies. These companies typically have a market value ranging from ₹5,000 crores to ₹20,000 crores. Mutual funds that invest in mid-cap companies are referred to as 'Mid-cap funds'.
Mid-cap companies, while still having a respectable track record, differ from large-cap companies in noticeable ways. Investing in mid-cap funds involves more risk compared to large-cap funds. Due to their limited market presence, mid-cap companies may or may not be included in broad market indexes.
With market values ranging from ₹5,000 crores to ₹20,000 crores, mid-cap companies are considered riskier investments than large-cap companies due to their higher volatility. However, they also possess the potential to grow into large-cap companies over time. Many investors are attracted to mid-cap stocks because of their higher growth potential compared to large-cap stocks.
Examples of Mid Cap Stocks (As of April 2024): Birlasoft, Dr. Lal Pathlabs, Aegis Logistics
Small Cap Stocks
Companies ranked from the 251st position onwards, based on their market value, are referred to as small-cap companies. These companies typically have a market value below ₹5,000 crores. Mutual funds that invest in small-cap companies are known as 'Small-cap funds'.
Small-cap companies often lack a long track record. For instance, start-up companies or those still in development fall into the small-cap category. Due to their limited presence in the market, these companies are usually not included in broad market indices.
With a market value of less than ₹5,000 crores, small-cap companies are relatively smaller in size but possess significant growth potential. However, their risk lies in the uncertainty of their success over time, leading to volatility in their stock prices. While small-cap stocks historically have underperformed, they often outperform other stocks when the economy recovers from a recession.
Examples of Small Cap Stocks (As pf April 2024):
Sunteck Realty Ltd, Empower India Ltd, Acrow India Ltd
Difference Between Small Caps, Mid Caps, and Large Caps
Let's look at some of the key differences between mutual funds that invest in Large Cap, Mid Cap, and Small Cap companies.
Criteria | Large Cap Funds | Mid Cap Funds | Small Cap Funds |
Market Capitalization of Companies | Top 100 companies by market cap | Ranked from 101 to 250 by market cap | Ranked beyond 250 by market cap |
Risk Profile | Lower | Moderate | Higher |
Volatility | Less volatile, stable | Moderate volatility | More volatile, less stable |
Liquidity | Good | Moderate | Less |
Growth Potential | Moderate, Lower than Mid and Small Caps | Moderate, Higher than Large Caps, lower than Small Caps | Higher than Large and Mid Caps |
Average Returns (past 5 yrs) | Around 7% | Approximately 10.28% | Approximately 14.74% |
Suitability | Conservative investors, long-term returns | Moderately risk-tolerant, long-term horizon | Aggressive investors, short-term horizon |
Reputation & Stability | Established, stable companies with good reputation | Moderate potential for growth, respectable track record | Considered to have significant growth potential, but uncertain stability |
Conclusion
As an investor, it's essential to understand the distinctions between small-cap, mid-cap, and large-cap funds and stocks. While large-cap investments offer stability and lower risk, Small Caps, Mid Caps investments provide the opportunity for higher growth potential, albeit with higher volatility and risk.
Ultimately, your investment decisions should align with your risk appetite, investment goals, and time horizon. Diversification across market capitalisations can help mitigate risks and optimize returns. It's always advisable to speak with your financial counsellor to tailor your investment strategy to your specific needs and preferences
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