August 17, 2021 | Ganesh Adhikari
A company’s market capitalization defines it as a small-cap stock or a big-cap stock. The criteria for separating publicly traded companies as small-cap and big-cap differs for different capital markets. Usually, large-cap stocks have market capitalizations of US$10 billion or greater, while small-cap corporations have between $300 million and $2 billion (in global context). Small-cap stocks tend to be fast growers whereas large-cap stocks are generally matured, established, and slow growers.
With less market capitalization small-cap stocks have fewer publicly traded shares. In countries like the US, small-cap has its index. Russell 2000 tracks 2000small companies in the US. In Nepal, microfinance companies fall under small-cap stocks.
Advantages of Small-Cap Stocks (Pros):
1. High Growth Potential
Small-cap companies have high growth potential. Some stocks have shown exponential annual growth be it in the US or Nepal. Thus, these stocks tend to have a high P/E (price to earnings) ratio. In Nepal, microfinance companies have performed exceptionally well. Most of these companies have exhibited growth of more than 30% annually. National Microfinance Laghubitta Bittiya Sanstha Limited (NMFBS), Deprosc Laghubitta Bittiya Sanstha Limited (DDBL), and Forward Microfinance Laghubitta Bittiya Sanstha Ltd. (FOWAD) to name a few.
2. Less Competition With Institutional Investors
Institutional investors such as banks, mutual funds, and hedge funds often try to make big bets and search for investment opportunities in large-cap stocks. This provides room for small investors to take advantage of investing in small-cap stocks which have huge growth potential.
3. Better Financial Gains
History suggests that small-cap companies have outperformed the market. Companies with small capitalization have high annual growth rates and the price movement is more volatile. The volatile price movements allow making financial gains in a short time.
Disadvantages Of Small-Cap Stocks (Cons):
1. Limited Liquidity
The daily trade volume of small-cap stocks is low compared to large-cap stocks. It might be a little more time to buy or sell the stocks of small-cap companies. When the market trend is downward, it might be hard to offload shares.
Prices tend to fluctuate quite frequently for companies with low market capitalization. One needs to be very careful while investing and should not act on fear or greed. Acting on rumors, following the crowd with the fear of missing out could be fatal strategies as the momentum of the market can change against your investment in a short space of time.
In the context of NEPSE, in the Bull Run of 2020/21, those stocks with less market capitalization have soared up as many as 5 times to their value during the bear. It won’t be surprising if they take a hard hit when the market looks for high correction or if the recession comes.
3. Lack of Transparency
There might be less data about the stocks’ past performance as many of them are not well established. Insider trading (illegal) can also play a huge role in price movements.
The market capitalizations are high and are usually well-established to pay consistent dividends. In the context of Nepal, commercial banks and investment companies fall under this category.
Advantages of Large-Cap Stocks (Pros):
1. Dividend Payouts
Large-cap companies lure investors with steady dividends. They are a good option for passive income. Since most of the large-cap companies are already established and are the leaders in the market, they pay dividends regularly to compensate shareholders.
Stability is the major attraction of large-cap companies. They are financially strong well-established with a good reputation among investors. Most of them are blue-chip companies. The companies are less likely to go out of business while regular revenues are expected to be generated. They are less risky investment options for your portfolio.
3. Availability of Data
Investors can get enough periodic financial statements about the company. There is transparency in financial statements, which helps to invest (buy or sell). Moreover, the management is well organized trusted to grow the company.
Disadvantages of Large-Cap Stocks (Cons):
1. Low Returns
Large-cap companies grow slow and steady, so the return on investment is lower compared to that of small-cap companies. They generally have an average growth rate of 10% – 12%.
2. Unattractive for Short-term Investors
The companies are better suited to buy and hold strategies rather than looking for short-term gains. Since the price movement and growth are quite stable, chances for making quick money come only occasionally.
Small-Cap and Large-Cap Stocks in Nepal
The attraction of small-cap companies is seen in the Nepalese stock market by investors. The market capitalization of some small-cap stocks is quite low such that their prices are easily manipulated by big market players or institutional investors. Some of the well-performing small-cap stocks in Nepal are:
- Swabhimaan Laghubitta Bittiya Sanstha Limited (SMFBS)
- Janautthan Samudayic Laghubitta Bittiya Sanstha Limited (JSLBB)
- Forward Microfinance Laghubitta Bittiya Sanstha Limited (FOWAD)
- Radhi Bidyut Company Limited (RADHI)
Large-cap stocks in the Nepalese Share market:
- Nepal Life Insurance Company Limited(NLIC)
- Nabil Bank Limited(NABIL)
- Global IME Bank Limited(GBIME)
- Citizen Investment Trust (CIT)
- Nepal Infrastructure Bank Limited (NIFRA)
- Nepal Reinsurance Company Limited (NRIC)
- Nepal Doorsanchar Company Limited (NTC)
Large-caps are certainly considered blue-chip companies in NEPSE, providing consistent dividends along with room for expansion in the growing economy of the nation. Most commercial banks such as NABIL are considered happy hunting grounds for a safe long-term investment approach. Most of the commercial banks have stable dividend history. On average 10% dividend is typically expected from most if not all commercial banks. Large-cap companies in other sectors are leaders of the market. NTC and CIT are matured and well established while NRIC and NIFRA are still finding their paths.
Small-cap companies, on the other hand, have comfortably outperformed large-cap companies while beating the market. Microfinance companies are the hottest stock sector in the NEPSE. Microfinance companies have established themselves as high dividend-paying companies which is not always the case with small caps. Low paid-up capital and huge growth potential have helped to sky-high the price of microfinance companies. But most hydropower companies with small-cap are over-hyped with no dividend-paying capacity.
If one wants stable income, can hold the stocks for long-term, large caps are best for them. For those who can handle volatility and desires the short-term gain should bet on small caps.
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