Ivan Illan is Chief Investment Officer at AWAIM® and bestselling author of Success as a Financial Advisor For Dummies.
With so much media attention directed toward companies with market capitalization significantly higher than $10 billion (e.g., S&P 500 constituents), it’s understandable that capital allocators and investors are challenged to adequately diversify their assets toward other market cap areas. To this end, understanding the debt and equity financing dynamic across various market cap segments may be highly informative as to whether the allocation risk is appropriate or not.
Bigger Isn’t Always Better
Mid-cap companies are generally worth between $2 billion and $10 billion, while small-cap companies are between $250 million and $2 billion. Importantly, different-sized companies access the capital markets in different ways to fuel their growth trajectory. While many small-cap companies are striving for profitability, many mid- and large-cap companies with more established profit margins can raise more capital at more favorable interest rates within the public debt markets through corporate bond issuance.
Everyone is familiar with large-cap stocks. A few examples include Amazon, Google, Microsoft and Apple. But trying to name companies that are mid-cap or small-cap is not as easy. Here are a few mid-cap stocks that have recognizable brands: DocuSign, Etsy, Wayfair and Zillow. A few small-cap companies that many would recognize include Upwork, Beyond Meat, Casper Sleep and SmileDirectClub. (Regulatory disclosure: AWAIM does not hold or recommend any of these individually mentioned stocks.)
Highlighting recognizable brands across the market cap spectrum is a reminder that industry growth is not relegated exclusively to the dominant players in any industry. In fact, industry leadership changes routinely over time. Just think back to the days when BlackBerry dominated the U.S. smartphone market with a 50% market share.
According to JPMorgan, more than 41% of companies in the Russell 2000 (a small-cap index) do not generate a profit. Meanwhile, only 17.5% of companies in the Russell MidCap (a mid-cap index) are unprofitable. Perhaps surprisingly, 7.4% of the companies within the S&P 500 are unprofitable. Therefore, no matter the size of the company, financial challenges may exist. Bigger is not always better.
U.S. corporations have continued to issue debt in the public debt markets. Through March 2024, there’s been almost $628 billion in new bond issuance, which is 81.0% year-over-year growth. Total outstanding corporate bond debt (as of Q4 2023) stands at $10.8 trillion, which represents an increase of 3.0% year-over-year. Debt financing continues to be an important and growing component of the U.S. corporate capital structure—even as interest rates remain high. Smaller companies may be more vulnerable than their mid- and large-cap brethren, in that they often have more floating rate exposure and less cash on hand.
Broaden Your Horizons
For capital allocators and investors, it’s prudent to look beyond the dominant U.S. large-cap stocks for future capital growth with portfolio diversification benefits. Case in point, the percentage of stock market capitalization in the information technology and industrial sectors within the S&P 500 is 29.8% and 8.6%, respectively. However, information technology represents only 13.9% in mid- and small-cap indexes—less than half that of the large-cap index. For industrials, mid- and small-cap sectors are 19.4% and 17.0% respectively—significantly more than the large-cap index.
When forecasting the impact of new technologies (such as AI), legacy industries stand to gain at least as much, if not more, than their more modern counterparts in terms of operational efficiency.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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