In 2008, some of the major market indexes reset the limits by which they separate large-cap, mid-cap, and small-cap stocks. The S&P 500, which is considered a benchmark for large-cap stocks, lowered the limit for inclusion in the index from $4.5 billion to $4 billion. Meanwhile, another index publisher, MSCI Barra, revised its large-cap definition to $7.5 billion, down from $11 billion.1
Similarly, falling stock prices allowed some money managers to buy stocks that were previously too big for their objectives while forcing them to sell others that no longer fit their portfolio rules. We may see more forced buying and selling on the part of institutional investors as stocks of all sizes continue to react to changing conditions.
The blurring of lines between large-cap, mid-cap, and small-cap companies is an indication that it may be time to evaluate whether your portfolio holdings have shifted toward or away from your investment objectives. The return and principal value of stocks fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost.
Cap and Trade
Calculating a companyâ€™s market capitalization is fairly simple: multiply the number of shares outstanding by the price per share. This number represents what the market believes the publicly traded portion of a company is worth. The distinctions between large, mid-size, and small companies are important because companies of different sizes tend to perform differently. The risks and benefits associated with large-cap companies can differ from those offered by smaller firms.
Large-cap stocks may react more slowly to changes in the markets than smaller-company stocks. The sheer volume of their outstanding shares tends to absorb both good news and bad, and the stock price may fluctuate less on a short-term basis.
At the other end of the spectrum, small-cap companies may offer less stability but greater return potential. Because there are fewer shares outstanding, the share prices of these companies may react more dramatically to good and bad news. These firms are more likely to be innovators and trendsetters than larger, established corporations.
But what happens when the market changes its mind about a stock? What happens when a small-cap stock grows into a mid-cap or large-cap â€” or vice versa? In such cases, itâ€™s wise to take a second look at your portfolio to determine whether a particular investment is still playing the role you need it to play. It may also be a good time to look around for opportunities created by shifting asset values. And this is where your investment objectives come into play. If you are an income investor, the way in which you view an asset typically differs from how a growth or value investor views it.
During periods of market volatility, itâ€™s a good idea to review your portfolio to determine whether it has taken on too much (or too little) risk or has drifted away from the mix that best suits your long-term objectives.