Market capitalization: is there a $ level at which the return diminishes?

Question

I'm no finance person (if you couldn't tell). Some people say buy small cap stocks b/c they're not as big as the large companies and their stock price tends to go up to a greater degree. If this is true, does it make sense that a $50 million market cap. company COULD return more to its shareholders than, say, a $650 million market cap. company? I realize that there exists many variables... and would appreciate real-world answers ---- no financial jargon if possible. Give it to me straight, like you'd tell the average joe on the street (that is, bring it down to a 10th grader's level!).

Thanks

Answer 1

It is true that in the past stocks of small companies outperformed stocks of large companies in the United States. There are several reasons that people put forth to explain this result:

- Small cap companies can grow faster by both increased market share and overall market growth.

- Small cap companies usually have more transparent accounting because it is harder to hide fraud in a small company.

However, academics still have a hard time to explain why small stocks outperformed large stocks on a risk-adjusted basis. In efficient markets, investors should realize that small companies (as a group) tend to perform better, and hence investors should bid up prices of small stocks up to the point that they do not outperform large stocks (on a risk-adjusted basis).

Answer 2

a large company has very high trading volume (lots of transactions, when you buy, you're buying from someone who sold), but the thing is, because there are so many participants offering and bidding, the price doesn't move as easily.

a less liquid stock such as a small cap generally receives very little in the way of trading volume, therefore, less transactional activity is required to result in participants moving the prices they're willing to deal at.