Small-cap stocks are shares of listed companies whose market capitalization is small compared with the rest of the market. In the United States, the group generally covers companies worth from a few hundred million dollars up to several billion: younger or more specialised businesses, regional banks, niche manufacturers and early-stage technology and biotech firms.
Small caps are the smallest of the three standard size groups, below mid-cap stocks and large-cap stocks. Below them sit micro-caps and the even smaller nano-caps, which carry higher risks. As with the other groups, no regulator defines the category, so index providers and research firms set their own boundaries. Small caps attract investors seeking higher long-term growth, and they are known for larger price swings than bigger companies.
Small-cap stocks in plain terms
Think of a young local bakery that has just opened its second shop. If it keeps winning customers, it could one day become a regional chain and its owners could multiply their money. But one bad winter, a broken oven or a rival opening across the street could also sink it, because it has little cash in reserve.
Small-cap stocks are shares in businesses at that stage. They have more room to grow than giant companies, which is the attraction. They also have fewer resources to fall back on, attract less attention from professional researchers and can be harder to sell quickly, so their share prices tend to jump around more.
Where the small-cap line is drawn
| Provider | Small-cap rule |
|---|---|
| S&P Dow Jones Indices | New additions to the S&P SmallCap 600 need an unadjusted market cap of US$1.2 billion to US$8.0 billion (guideline updated 1 July 2025; reviewed quarterly). |
| FTSE Russell | The Russell 2000 covers the 2,000 US companies ranked below the largest 1,000. |
| MSCI | The small-cap segment covers roughly the band between about 85% and about 99% of each market's cumulative free-float-adjusted value. |
| Morningstar | Stocks below the top 90% of cumulative market value are treated as small cap. |
Older rules of thumb, such as "under $2 billion", are still widely repeated, but the main index bands have moved upwards as markets have grown. Investor.gov, the SEC's investor education site, describes microcap stocks as those of companies with a market capitalization below roughly $250 million to $300 million.
Small-cap indexes
The Russell 2000, launched by the Frank Russell Company in 1984, is the most widely quoted US small-cap benchmark. It is built purely by size rank, so it includes many companies that are not yet profitable. The S&P SmallCap 600, launched in 1994, adds a profitability requirement for new members, which tends to give it a higher-quality mix; the two indexes can therefore produce noticeably different returns. Outside the US, MSCI publishes small-cap indexes by country and region, and the FTSE SmallCap index covers smaller UK companies. Small-cap equity funds and exchange-traded funds (ETFs) track these benchmarks.
In 1981 the economist Rolf Banz published research showing that, over long periods of US history, smaller companies had earned higher average returns than larger ones, even after adjusting for market risk. Eugene Fama and Kenneth French later included company size as one of the factors in their model of stock returns. The usual explanations are that investors demand extra reward for the higher risk, weaker liquidity and thinner information that come with small companies.
The premium has been inconsistent. Small caps have lagged large caps for long stretches, including much of the period after the 2008 financial crisis, when a handful of giant technology companies drove US market returns. Researchers continue to debate whether the size effect still exists or is mostly concentrated in the smallest, least liquid stocks.
Risks of small-cap investing
- Volatility. Small caps usually show higher volatility and a higher beta than large caps, and can fall sharply in a bear market or recession.
- Funding and rates. Smaller companies rely more on bank loans and floating-rate borrowing, so rising interest rates can hit their profits harder.
- Trading costs. Lower trading volume means wider spreads between buying and selling prices, and large orders can move the price.
- Thin coverage. Fewer analysts follow small caps, so information gaps and mispricing are more common, in both directions.
- Fraud risk at the bottom end. Thinly traded micro-caps are frequent targets of pump-and-dump schemes, in which promoters inflate a price and then sell.
Because of these risks, small caps usually form a modest slice of a diversified portfolio, sized to the investor's risk tolerance and time horizon. Some small caps are fast-growing growth stocks; others are unloved value stocks, a combination that index providers track separately as small-cap growth and small-cap value. Spreading money across many companies through diversification matters more here than with large, established blue chip stocks.