Small-cap companies are corporations that have a total market capitalization that is less than $1 billion US Dollars (USD). Market capitalization is a method of determining the value of a company using its shares. A company’s value is determined by multiplying its number of shares by the value of each share. In the past, small-cap companies were the smallest designation of company size, but changes in business practices in the last several years have called for even smaller categories.
Market capitalization is a quick and dirty method of figuring the value of a company. It does not take into account extenuating circumstances, such as market fluctuations or company debts. Any of these circumstances can have a huge impact on the company’s final value. Many times, a person finding the market capitalization is simply doing it to get a basic estimate of the company’s size. For a more detailed analysis of the company’s market power, people often use enterprise value.
Regardless of its overall accuracy, the ‘cap’ part of small-cap companies stands for capitalization. This designation refers to the company’s overall ability to affect the market. A small company doesn't have enough influence to create any long term effects on the market. Larger, medium-cap companies have more of an impact, but typically only in short terms. Large-cap and mega-cap companies can have an impact on the direction of the market and produce noticeable effects on smaller companies.
While the current definition of small-cap is $1 billion USD, that number changes with time. Back when the designation was new, a $1 billion USD company was quite large. As time went forward and inflation changed the relative value of money, the designation changed to match it. It is very likely that in time, small-cap will be changed to a value higher than $1 billion USD.
Changes in the modern marketplace have precipitated changes in the cap designation system. In the original system, small-cap companies were the smallest, with medium and large-cap making up the rest. Modern international corporate giants caused the need for the mega-cap designation. On the other end of the scale, small one- and two-person startups make up the nano and micro-cap levels. Like small-cap, each of these levels has a relative share-value range.
One of the main reasons for chopping up companies into their levels is to determine investment strategies. As the levels increase, the price of the companies stabilize. For instance, small-cap companies are more variable than large-cap ones. For investors, this means that a company in the upper tiers is a safer, but likely lower-yield, investment. Lower-tiered stocks are very volatile and prone to sharp highs and lows.