Methodology

Stocks

Module 2

Company Size

An important characteristic that can influence the performance of stock is the size of the company.

Larger companies tend to grow at a slower rate than smaller companies, which means that the stock price of larger companies will increase in value at a slower rate over time.

On the other hand, smaller companies can grow very quickly, meaning that their stock price can increase dramatically.

To illustrate this difference, an investor may expect to earn around 10% a year when investing in a larger company or 40% a year when investing in a smaller company.

As much as smaller companies can increase their stock price very dramatically, it is important to note that their stock price will be less stable and could sharply decline when things go wrong in the business.

Smaller companies are less predictable, meaning that an investor could earn a large return at one moment, only to lose an even larger amount of money later on.

What are small and large companies?

When discussing company size, it is often hard to know what the difference between a large and small company is.

The way to determine the size of a company is to find the market capitalisation of the stock. This figure can be used to categorise a company as being large or small.

A small firm on the stock market is generally viewed as a company that has a market cap between $300m and $2bn. In contrast, companies with a market cap of more than $10bn are seen as large companies.

The majority of the most famous brands in the world are considered to be large companies. Microsoft, for example, have a market capitalisation of $2.14 trillion, easily falling into the category of being a large company.

Most of the smaller companies on the stock market are not so well known, which means that they do not receive as much attention as large companies. This explains why the stock price of many small companies can change so dramatically.

An objective for many investors is to invest in a small company just before it becomes large company, making a huge profit in the process.

However, it is important to remember that few small companies will become large companies, so this is a very difficult thing to achieve.

Risk and Company Size

As you may have guessed by now, the size of companies that you decide to invest in have an impact on the risk of your investments.

Investing in small companies is significantly more risky than investing in large companies, which is why the potential returns are higher for smaller companies.

Unless you want to invest with a very high level of risk, it is usually more appropriate to invest in large companies as they have a longer track record and are usually more stable.

As a consequence of not having a track record, smaller companies tend to experience huge swings in their stock price. Small companies are also much more likely to go out of business, meaning that there is a greater chance that the stock price of such companies goes to $0.

It is important to invest in companies that match your risk profile. Therefore, the size of the companies that you invest in should be a key consideration.

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