Small-Cap, Mid-Cap Or Large-Cap Stocks: Which Is A Better Investment?

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 |  Includes: IJR, MDY, OEF, SPY
by: Arie Goren

An investor in the American stock market trying to outperform the overall market by stocks or fund picking would usually have to decide on what size of companies to invest in. When talking about size we usually mean the market-cap: the number of shares outstanding of a company multiplied by the share price. Big companies tend to be less risky than small companies. But smaller companies can often offer more growth potential.

While there is no official breakdown, the division between the large, medium and small cap is approximately as follows:

  • Large-cap: $10 billion and greater
  • Mid-cap: $1 billion-$10 billion
  • Small-cap: $100 million-$1 billion

In the following study, I have compared the performance of the different groups of American stocks according to their size in the current year; future studies will show their performance in different time periods. In addition to the returns by price appreciation, I also looked into the dividends contribution to the total returns and calculated the Sharpe ratio. The Sharpe ratio is a very important indicator to the reward to risk ratio. Following is the definition of "Sharpe Ratio" by Investopedia (here):

A ratio developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 10-year U.S. Treasury bond - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

Since the risk-free rate this year is insignificant, I used the adjusted Sharpe Ratio, which is the rate of return divided by the standard deviation of the group returns, ignoring the risk-free rate. Obviously past behavior is not necessarily expected to repeat itself in the future, but nevertheless, studying past performance helps us identify developing trends.

I have chosen the four well known stock indexes of Standard & Poor's in order to identify the group of stocks according to their size. The four stock indexes are as follows:

S&P SmallCap 600

Description from Standard & Poor's:

The S&P SmallCap 600 covers approximately 3% of the domestic equities market. Measuring the small cap segment of the market that is typically renowned for poor trading liquidity and financial instability, the index is designed to be an efficient portfolio of companies that meet specific inclusion criteria to ensure that they are investable and financially viable.

S&P MidCap 400

Description from Standard & Poor's:

The S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index covers over 7% of the U.S. equity market, and seeks to remain an accurate measure of mid-sized companies, reflecting the risk and return characteristics of the broader mid-cap universe on an on-going basis.

S&P 500 Index

Description from Standard & Poor's:

Widely regarded as the best single gauge of the U.S. equities market, this world-renowned index includes 500 leading companies in leading industries of the U.S. economy. Although the S&P 500® focuses on the large cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. S&P 500 is part of a series of S&P U.S. indices that can be used as building blocks for portfolio construction.

S&P 100 Index

Description from Standard & Poor's:

The S&P 100 Index, a sub-set of the S&P 500®, measures the performance of large cap companies in the United States. Known by its ticker symbol, OEX, the index is comprised of 100 major, blue chip companies across multiple industry groups. The primary criterion for index inclusion is the availability of individual stock options for each constituent.

In order to compare the different index's performance, I used the most traded ETFs corresponding to the four S&P indexes, as shown in the table below.

No.

Type

Index

ETF Name

Symbol

1

Small-Cap

S&P SmallCap 600

iShares Core S&P Small-Cap ETF

(NYSEARCA:IJR)

2

Mid-Cap

S&P MidCap 400

SPDR S&P MidCap 400

(NYSEARCA:MDY)

3

Large-Cap

S&P 500

SPDR S&P 500

(NYSEARCA:SPY)

4

Major Large-Cap

S&P 100

iShares S&P 100 Index

(NYSEARCA:OEF)

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The table below presents the total return and the calculated annual return between December 30, 2011 and December 11, 2012 for the four ETFs. The returns without dividends and with dividends are shown separately, in order to emphasize the importance of the dividend yield. All funds' quotes and adjusted for dividends quotes were extracted from Yahoo Finance.

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The chart below presents the total return between December 30, 2011 and December 11, 2012.

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The table clearly shows that the small-cap group has been the worst performer year to date with a total return with dividends of 14.14%, without the dividends the total return would be 13.07%. The best performer has been the mid-cap group with a total return with dividends of 16.76% and without dividends of 15.89%. The total returns of the large-cap group and the major large-cap group were not far from the mid-cap group, in this case the contribution of dividends has been more significant. Dividends have contributed 1.70% to the major large-cap group return, 1.71% of the large-cap group return, 0.87% of the mid-cap group return and 1.07% of the small-cap group return.

The table and the charts below present the adjusted Sharpe ratio without dividends and with dividends for the four ETFs.

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The table and the chart show that although the middle-cap group has given the highest return, the adjusted Sharpe ratio for the major large-cap and the large-cap groups have been much higher, which mean better reward to risk ratio. That is because the big size stocks are less volatile.

Summary

The large-cap stocks have been the clear winners among the American stocks in 2012, maybe due to the global financial crisis, investors have been less ready to invest in small size companies, which are considered riskier. It is most probable that if the world economy will turn to fast growth again, the small size stocks will outperform the general market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.