Market Capitalization: An Overview
June 20, 2011
As you sit and watch the financial news, or read other financial articles, you will constantly hear about this large-cap company or that small-cap, etc. What do these terms mean? Which companies fall where? And most importantly, why does it matter?
The first thing we need to do when discussing this topic is define what market capitalization is. This term represents the size of a corporation in regards to value. The market cap of a company is equal to the share price of its stock multiplied by the shares outstanding. For example:
Company ABC stock price: $10.00
Company Shares Outstanding: x 10,000,000
Company Market Cap: $100,000,000
How a company is described in reference to market cap depends on the size. There are five categories that are regularly discussed. So much so, that there are indexes, mutual funds, ETFs and sectors built around these. These numbers are not set in stone and may even vary by country. The following would be a good benchmark to use for comparison:
Mega-Cap: Over $200 billion
Large-Cap: $10 billion – $200 billion
Mid-Cap: $2 billion – $10 billion
Small-Cap: $250 million – $2 billion
Micro-Cap: $50 million – $250 million
These are truly the biggest companies in the world. Names like Microsoft, ExxonMobil and Johnson & Johnson fall into this category. It used to be that these big companies were considered pretty safe investments “too big to fail” if you will. We found that not to be the case over the last few years.
This is probably the most popular segment in regards to investing. The S&P is built on these stocks. Names like Wal-mart, Coca Cola & Apple fall into this category. As discussed in a previous post, there is an argument for index investing and just taking advantage of the natural growth and movements of the market. The more sophisticated investor will disagree, but then not everybody falls into that category either.
This segment is probably the most over-looked by the average investor and it is possibly their biggest mistake. Mid-cap stocks benefit from being like their larger brothers, in that they have established track records both in financial statements and share price. They are less risky than smaller companies, and yet they have only truly seen the beginning of their growth. According to Morningstar, the Mid-Cap 400 Index has outperformed the S&P in both the 5 year & 10 year time frames.
These segments are the area where many sophisticated investors and day traders play. The volatility is much higher here and the potential to wither win big or crash and burn is much higher. The hard part here is the limited information available for many of these stocks.
Each of these segments of the market has their reasons why you should or should not use them in your portfolio. Whether you do or not is entirely up to you. At least now when you hear those analysts rattle on about small-caps outperforming, you will know what they are talking about.
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