Pros and cons of choosing stocks by market cap
Pros of choosing stocks by market cap
Market capitalisation is commonly used to help inform decisions about which stock to invest in because it gives investors information about the relative size of one company versus another. This is why investors tend to split stocks into categories based on their market capitalisation: large-cap, mid-cap and small-cap.
Large-cap companies typically have a market capitalisation of $10 billion or more, mid-cap companies between $2 billion and $10 billion, and small-cap companies between $300 million and $2 billion. The cut-off values of each category can be vague, and differ from country to country.
Market capitalisation is a simple and relatively effective way to assess risk. Investing in large-cap companies is thought to provide long-term rewards and less risk, as the companies are well established and stable. Mid-cap companies have great growth potential but tend to be riskier than large-cap stocks, although not as risky as small-cap stocks. Small-cap companies are often considered a high-risk investment choice due to factors like their limited financial resources.
Cons of choosing stocks by market cap
Although there can be a variety of benefits of using market capitalisation to identify which stocks to invest in, there are also certain limitations to this method. For instance, a business’s worth (its enterprise value) is not accurately reflected in the market cap – it only reflects equity value. Share prices may be over- or undervalued, because they only reflect how much the market is willing to spend.
What Is Market Cap? Defined and Explained
Market cap refers to the total value of a publicly traded company's shares. Shorthand for "market capitalization," market cap is one way an investor can evaluate how much a company is worth.
To determine a company's market cap, simply multiply the share price by the number of shares outstanding.
Here's Costco Wholesale (NASDAQ:COST) as an example. At recent prices, Costco shares sell for $302.45, with 441.52 million shares outstanding. In this case, $302.45 times 441.52 million equals a $133.54 billion market cap.
But why is market cap important and how should you use it? It's one of the best measures of a company's size, which can tell you a lot about what to expect if you buy its stock.
- Large companies tend to have more stable and mature businesses, having proven themselves over time and weathered difficult business conditions to emerge stronger. However, the growth prospects for large companies can be limited because they've already taken advantage of their primary opportunities to grow to their current size.
- Smaller companies often have more room to grow, but they are typically younger, with riskier business models that haven't yet proved themselves. Their odds of failure can be higher than those of larger companies, which presents added risk.
Here's a quick breakdown of how market cap ranges are often segmented across companies of different sizes:
Type of Stock
Market Capitalization Range
More than $200 billion
$10 billion to $200 billion
$2 billion to $10 billion
$300 million to $2 billion
$50 million to $300 million
Chart by author.
In general, investors look at the market in the following three categories most often since these are the market cap categories most stocks tend to fall into.
What are large-cap stocks?
Large-cap stocks have market caps of more than $10 billion. Most of the best-known companies in the world are large caps, and these are typically the companies that have established themselves as the leaders in their industries. While many deal with the ups and downs of their industry's cycles, these are often the strongest companies and have proven capable of holding off competitive threats. Large caps are often where you'll find the best dividend stocks. These large companies often generate more cash than they need for the business and return that extra capital to investors in dividend payments.
Read More:Large-Cap Stocks
What are mid-cap stocks?
Mid-cap stocks have market caps between $2 and $10 billion, occupying the middle ground between large and small companies. Mid-cap companies often have made considerable progress in building up successful business models, and that gives their investors some stability and protection against the future challenges smaller companies may face. Yet even with some track record, mid caps also may face the daunting task of beating out, or even disrupting, bigger and better-funded large-cap competitors to realize their own financial promise.
Not all mid caps are growth stocks. They may be companies that operate in a smaller niche without big growth prospects, or they may be former large caps that have declined due to changes in the competitive landscape or (as with many brick-and-mortar retailers) some industry disruption.
What are small-cap stocks?
Small-cap stocks are generally defined as having market caps between $300 million and $2 billion. Sometimes companies with market caps below $300 million are in this group, although most categorize those as micro-cap stocks. They are generally growth stocks or upstarts just getting their feet under them and looking to do something big. While small-cap stocks have historically delivered above-average returns as a group, many fail to live up to expectations. Small-cap stocks are more volatile than larger caps, meaning there is more risk of losses in the short term. These stocks are generally best owned as a diversified group, and for many years, in order to reduce those risks.
Read More:Small-Cap Stocks
How to use market cap
Market cap is helpful when evaluating a company's size. But don't let the market value of a company cause you to dismiss large- or even mega-cap stocks as "too big to buy." The global economy is enormous, serving more than 7 billion people and with a fast-growing middle class. A $10 billion company that serves a multi-trillion-dollar market can grow substantially.
Moreover, companies can deliver strong per-share returns without expanding their market cap fast. Share repurchases that reduce the share count reward long-term investors with a bigger piece of the company, while dividends put money directly back into your pocket. These two things combined can significantly reduce how much market cap needs to grow for investors to get above-average returns.
Conversely, companies -- often small caps that need the cash -- may sell stock to fund growth, pay debt, or just keep the lights on. When this happens, it reduces -- dilutes -- how much of the company each share is worth. For example, if a company with 10 million shares issues and sells 1 million new shares, 10% of your former equity now belongs to the new shareholders. The key here is to consider a company's history of share buybacks and dilution.
Most investors find that having a diversified portfolio that includes stocks of various market caps is best. It lets you tailor for the desired return and risk levels that meet your goals. If you want your portfolio to be more stable, you'll want a bigger allocation of large-cap stocks. If your primary goal is to increase your portfolio's size as much possible over many years, you'll likely want to own more small- and mid-cap stocks.
What Is Market Capitalization?
Market capitalization refers to the total dollar market value of a company's outstanding shares of stock. Commonly referred to as "market cap," it is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share.
As an example, a company with 10 million shares selling for $100 each would have a market cap of $1 billion. The investment community uses this figure to determine a company's size, as opposed to using sales or total asset figures. In an acquisition, the market cap is used to determine whether a takeover candidate represents a good value or not to the acquirer.
- Market capitalization refers to how much a company is worth as determined by the stock market. It is defined as the total market value of all outstanding shares.
- To calculate a company's market cap, multiply the number of outstanding shares by the current market value of one share.
- Companies are typically divided according to market capitalization: large-cap ($10 billion or more), mid-cap ($2 billion to $10 billion), and small-cap ($300 million to $2 billion).
Understanding Market Capitalization
Understanding what a company is worth is an important task, and often difficult to quickly and accurately ascertain. Market capitalization is a quick and easy method for estimating a company's value by extrapolating what the market thinks it is worth for publicly traded companies. In such a case, simply multiply the share price by the number of available shares.
Using market capitalization to show the size of a company is important because company size is a basic determinant of various characteristics in which investors are interested, including risk. It is also easy to calculate. A company with 20 million shares selling at $100 a share would have a market cap of $2 billion. A second company with a share price of $1,000 but only 10,000 shares outstanding, on the other hand, would only have a market cap of $10 million.
A company's market cap is first established via an initial public offering (IPO). Before an IPO, the company that wishes to go public enlists an investment bank to employ valuation techniques to derive a company's value and to determine how many shares will be offered to the public and at what price. For example, a company whose IPO value is set at $100 million by its investment bank may decide to issue 10 million shares at $10 per share or they may equivalently want to issue 20 million at $5 a share. In either instance, the initial market cap would be $100 million.
After a company goes public and starts trading on the exchange, its price is determined by supply and demand for its shares in the market. If there is a high demand for its shares due to favorable factors, the price would increase. If the company's future growth potential doesn't look good, sellers of the stock could drive down its price. The market cap then becomes a real-time estimate of the company's value.
The formula for market capitalization is:
Market cap = share price x # shares outstanding
Market Cap and Investment Strategy
Given its simplicity and effectiveness for risk assessment, the market cap can be a helpful metric in determining which stocks you are interested in, and how to diversify your portfolio with companies of different sizes.
Large-cap, or big-cap, companies typically have a market capitalization of $10 billion or more. These large companies have usually been around for a long time, and they are major players in well-established industries. Investing in large-cap companies does not necessarily bring in huge returns in a short period of time, but over the long run, these companies generally reward investors with a consistent increase in share value and dividend payments. An example of a large-cap company is International Business Machines (IBM), Johnson & Johnson (JNJ), or Microsoft (MSFT).
Mid-cap companies generally have a market capitalization of between $2 billion and $10 billion. Mid-cap companies are established companies that operate in an industry expected to experience rapid growth. Mid-cap companies are in the process of expanding. They carry an inherently higher risk than large-cap companies because they are not as established, but they are attractive for their growth potential. An example of a mid-cap company is Eagle Materials (EXP).
Companies that have a market capitalization of between $300 million to $2 billion are generally classified as small-cap companies. These small companies could be younger and/or they could serve niche markets and new industries. These companies are considered higher-risk investments due to their age, the markets they serve, and their size. Smaller companies with fewer resources are more sensitive to economic slowdowns.
As a result, small-cap share prices tend to be more volatile and less liquid than more mature and larger companies. At the same time, small companies often provide greater growth opportunities than large caps. Even smaller companies are known as micro-cap, with values between approximately $50 million and $300 million.
In order to make an investment decision, you may need to factor in the market cap of some investments.
Misconceptions About Market Caps
Although it is used often to describe a company, the market cap does not measure the equity value of a company. Only a thorough analysis of a company's fundamentals can do that. It is inadequate to value a company because the market price on which it is based does not necessarily reflect how much a piece of the business is worth. Shares are often over- or undervalued by the market, meaning the market price determines only how much the market is willing to pay for its shares.
Although it measures the cost of buying all of a company's shares, the market cap does not determine the amount the company would cost to acquire in a merger transaction. A better method of calculating the price of acquiring a business outright is the enterprise value.
Changes in Market Cap
Two main factors can alter a company's market cap: significant changes in the price of a stock or when a company issues or repurchases shares. An investor who exercises a large number of warrants can also increase the number of shares on the market and negatively affect shareholders in a process known as dilution.
What Is Market Capitalization?
Market capitalization refers to the market value of a company’s equity. It is a simple but important measure that is calculated by multiplying a company’s shares outstanding by its price per share. For example, a company priced at $20 per share and with 100 million shares outstanding would have a market capitalization of $2 billion.
Is It Better to Have a Large Market Capitalization?
There are advantages and drawbacks to having a large market capitalization. On the one hand, larger companies might be able to secure better financing terms from banks and by selling corporate bonds. Also, these companies might benefit from competitive advantages related to their sizes, such as economies of scale or widespread brand recognition.
On the other hand, large companies might have limited opportunities for continued growth, and may therefore see their growth rates decline over time.
What Is the Difference Between Market Capitalization and Enterprise Value?
The key difference between market capitalization and enterprise value is that market capitalization reflects only the value of a company’s equity, whereas enterprise value reflects the total amount of capital—including from debt—invested in the business.
Specifically, enterprise value is calculated by taking the company’s market capitalization, adding its total debts, and subtracting its cash. Many investors use enterprise value as a rough estimate of the cost of acquiring the company and taking it private. It is also used in valuation ratios such as the enterprise multiple.
How Can I Use Market Capitalization to Evaluate a Stock?
Market capitalization is a useful figure to examine when trying to understand a company's structure and profitability, and therefore a stock's value. It can be used to determine a variety of key performance metrics, including price-to-earnings and price-to-free-cash flow.
Market capitalization refers to the total dollar market value of a company's outstanding shares. Colloquially called "market cap," it is calculated by multiplying the total number of a company's shares by the current market price of one share. The investment community uses this figure to determine a company's size, and basically how the stock market is valuing the company.
- Market capitalization is the total dollar value of all of a company's outstanding shares.
- It's determined by multiplying the company's stock price by its total number of outstanding shares.
- Investors can use market capitalization to assess the value of a stock they are considering buying.
- Market capitalization is a key measure of profitability that is also used in equations to determine price-to-earnings and other significant metrics.
- Market cap is generally broken down as micro cap, small cap, mid cap, large cap and ultra or mega cap.
Performance Metrics That Use Market Cap
There are a number of popular valuation ratios that include market capitalization that investors should look at when considering buying a stock. These ratios include:
Generally, large-cap stocks are slower growth and therefore more likely to pay dividends than faster growing, small- or mid-cap stocks.
Market Cap Types
There is no official barrier for different categories of stocks based on size, but large caps are often companies with market caps over $10 billion, while mid caps are $2 billion to $10 billion, and small caps are under $2 billion. There are further categories that investors will sometimes consider, such as micro caps, referring to small-cap stocks that are under $250 million, and ultra or mega cap stocks, which are large caps that are over $50 billion.
Market capitalization is used to set investor expectations and shape investment strategy. Different types of investment strategies focus on the various market cap groups, and different valuation methods are applied depending on company size. Very large market caps are usually associated with mature, low-growth companies that pay dividends. Small caps are often growth companies with higher-risk profiles and generally do not pay dividends.
What's A Company’s Worth, And Who Determines Its Stock Price?
Indicate market what does cap
Does a Large Market Capitalization Indicate a Better Company?
If your investment strategy is based on long-term goals, then you need to understand the relationship between the size of a company, the potential return you could get on it, and the risk. When you know that, then you can better balance your stock portfolio so it can have different market caps.
Market capitalization, also known as market cap, is simply the total value of a company’s shares. Note here that the discussion is about the shares that sell among the public and not such things as preferred stock. If a company sells at $40 a share and has 20 million shares selling among the public, then it has a market capitalization of $800 million dollars.
So, why is this concept so important to investors and analysts alike? Why do you have to care? The market capitalization of a company can give investors an indication of the size of the company and can even be used to compare the size of one company to another. The concept can also give an indication of what the market thinks about the future prospects of that company since the market capitalization is a measure of how much the public is willing to pay for the stock of the company in question.
These are typically companies that have a market valuation of more than $10 billion. Large-cap companies are historically known to produce high-quality goods and high-quality services. The dividend payments are consistent and the growth is steady. They often tend to dominate their industries, which are in turn well established and mature. The brand names of large-cap companies tend to be easily recognized by consumers.
Because of this, large-cap stocks tend to be considered fairly conservative investments when compared to their mid-cap and small-cap counterparts and don’t pose as much risk. In return, the growth potential is a lot less aggressive.
These are typically companies that have a market valuation of between $2 billion and $10 billion. These are established companies that operate in industries that are either experiencing rapid growth or are poised to experience rapid growth in the near future. These companies are typically increasing their market share and becoming more and more competitive in their niches. The way a company performs at this stage is a good indicator of the possibility of it living up to its full potential.
Stocks of such companies tend to be midway between the risk-return profiles of large-cap and small-cap stocks. They generally offer more growth potential than large-cap stocks but not as much as small-cap stocks. They also offer less risk than small-cap stocks but more than large-cap stocks.
These companies typically have a market valuation between $300 million and $2 billion. These are your typical young company that is growing in an emerging industry or a niche market in an established industry. These companies are the most aggressive of the three types when it comes to growth potential and also happen to be the riskiest. They have relatively limited resources and so they are more vulnerable to downturns in the economy or the industry within which they operate. They are also prone to competition and the uncertainties that tend to plague emerging industries in their infancy.
Small caps do come with their advantages, however. They offer the highest growth potential of the three types and can be an excellent long-term investment for you, so long as you can tolerate the short-term volatility that often plagues such stocks.
Calculating Market Capitalization
The market capitalization of a company is based on the total value of all of the shares of the company. There is a useful concept here known as the float, which is simply all of the outstanding stock of the company that is available for trading by the general public.
When you calculate market capitalization using the free float method, which is the most common method of calculating it, you don’t count any locked-in stock, such as the stock held by governments and the executives of the company. This method of calculating market capitalization is used by most of the major indexes around the world, including the S&P 500 and the Dow Jones Industrial Average.
The Factors That Affect Market Capitalization
There are several ways in which the market cap of a company could be affected.
For example, when there is a significant change in the value of the shares of the company, whether that change is positive or negative, then the market capitalization could be affected. The same would be true if there is a significant change in the number of shares issued by the company.
Whenever a warrant is exercised on the stock of a company, then there will be an increase in the number of outstanding shares that the company has. When that happens, the value of each individual share is diluted and so the overall market capitalization of the company is reduced. When the exercise of warrants on stock happens, it is usually done at a price below the market price of the shares, making the effect on market capitalization even greater.
Market capitalization isn’t affected by the issuing of a dividend or a stock split. When a stock split happens, then the price of a single share is reduced since the number of shares outstanding has gone up. So, for example, when a two for one stock split happens then the price of each share will be split in half. The number of outstanding shares in the company has doubled but that effect has been offset by the fact that the individual price of a share has halved. The market cap, therefore, remains the same. The same applies in the event that a company issues a dividend. When a company issues a dividend, it increases the number of shares that are held by shareholders and so the price of a share drops proportionally.
The Advantages of Large-Cap Stocks
Large-cap companies have certain advantages over their mid-cap and small-cap counterparts. Their stocks experience a lot less volatility to begin with because their goods and services are proven on both a national and international scale. Investors see them as more attractive on account of their stability and also the fact that they tend to offer consistent dividends. That makes them a better bet for conservative investors.
The Disadvantages of Large-Cap Stocks
One of the main limitations that such companies face is their limited growth rate. They are so big and so established that they don’t really have a horizon to expand into. They, therefore, have a much lower potential for growth than their smaller cap counterparts. A small company can become large very quickly, because there are a lot of new markets for it to expand into. A large company, on the other hand, doesn’t have as many opportunities to expand into new markets because it has already done so in the past. As an investor, you can find a small-cap stock more attractive because it has greater potential for growth in both the short- and long-term.
As an investor, your portfolio should contain an appropriate mix of large-, small-, and mid-cap stocks. To determine what the proper mix is you’ll need to determine your financial goals, your time horizon, and your tolerance level for risk. All the same, a diversified portfolio will spread out your risk and help you attain your financial goals more easily.
Nicky is a business writer with nearly two decades of hands-on and publishing experience. She's been published in several business publications, including The Employment Times, Web Hosting Sun and WOW! Women on Writing. She also studied business in college.
Market capitalization tells you how much a company is worth, and whether buying its stock suits your overall investing strategy
- Market capitalization ("market cap") is the total value of all a company's stock: the number of outstanding shares by the share price.
- Stocks are often categorized by the size of their market capitalization: large-cap, mid-cap, small-cap, or micro-cap.
- An indicator of financial strength, market capitalization suggests how risky a stock is and what kinds of returns it might offer.
- Visit Business Insider's Investing Reference library for more stories.
A big part of the investing game is trying to figure out what a company is worth. If you can measure a company's value, you'll be in a better position to know whether you want to commit your hard-earned capital to its stock.
Of course, a variety of ways exist to evaluate public companies and their stock. One of the most common is by market capitalization, or "market cap" for short.
A company's market capitalization is what it would cost you if you were to buy up all of its outstanding shares at the current share price. It is a way of sizing up a company by the value that investors put on it.
Here's how it works, and why it matters to your investing strategy.
What is market capitalization?
Market capitalization is essentially the total value of a company's outstanding stock.
Expressed in dollar figures (or whatever the local currency), it's made up of two factors: the number of a company's outstanding shares, and the price of each share.
A company's market cap is often included in its online stock listing or company profile. But figuring it out isn't all that hard. To calculate the market capitalization you simply multiply the number of shares outstanding by the price per share.
For example, a company that has 50 million outstanding shares and a share price of $10 has a market capitalization of $500 million.
We could use Apple (AAPL) as a real-life example. As of December 2020, Apple has about 17 billion shares outstanding. The price of Apple's stock is at $113.85 per share. To calculate the market capitalization, we multiply the two and get about $1,921 billion.
What makes market capitalization change?
Since it depends directly on a company's stock price, market capitalization changes every day. As the price of a company's stock goes up, so does its market capitalization, and vice versa.
Changes in the number of outstanding shares also influences market capitalization. Companies sometimes issue additional shares to raise capital or buy back shares. Assuming a constant share price, issuing shares would increase market capitalization and buying them back would decrease it.
Market capitalization categories and investment strategies
You'll often hear companies classified in terms of their market capitalization. Based on dollar size, these classifications can also help investors pick the right stocks for their investment goals and risk tolerance.
The most common market cap categories for stocks are:
- Micro-cap and nano-cap
Although no official or legal designations exist, there are generally agreed-upon boundaries for each market cap category.
Large-caps have a market capitalization of over $10 billion. They are are very large companies, usually those with a long history and a household name: Apple, Visa, Johnson & Johnson, Walmart.
They are typically less risky investments, given that they're backed by years of stable earnings and stock price performance. However, as mature corporations, they also usually do not grow very quickly.
For investors, that means large-cap stocks may bring steady — but not massive — returns. Most blue-chip stocks are large-caps.
Mid-caps have a market capitalization between $2 and $10 billion. They are usually sizable, well-established companies. Some may be familiar names, like American Eagle Outfitters, Lending Tree, and TripAdvisor; others might be less well-known, but are respected and fast-rising in their field, like Peloton or Diamondback Energy.
As their name suggests, mid-caps occupy a middle ground for investors: They may be riskier than large-caps, but are still relatively safe (certainly more so than the small-caps, from whose ranks they often spring). Their stock can be more volatile than large-caps', but it also may also have more potential for appreciation, as many of these companies are still actively growing.
Small-cap companies are riskier still. But with a market capitalization between $300 million and $2 billion, they can provide opportunities for major appreciation; in fact, these firms are often the darlings of growth-oriented investors. Getting in on the ground floor of a successful small-cap company can be very lucrative — if you guess right. But it may take time for it to pay off, and unlike the large- or mid-caps, it probably won't be providing much in terms of dividends or other returns in the meanwhile.
Small-cap companies include Neophotonics Corp., Unisys Corp., and Purple Innovation.
Micro-cap and nano-cap valuation
Smaller companies can be divided even further. Micro-caps are typically companies that have a market capitalization between $50 million and $300 million. Nano-caps are those with a market capitalization below $50 million.
These are often very risky investments with lots of volatility. Most penny stocks fall into the nano- or micro- categories.
Why is market capitalization important?
Market cap is an important concept because it allows investors to understand the size of a company and how much its worth on the market. Since companies of different market-cap sizes vary in terms of their growth potential, income payments, and risk, spreading your investments among them is one way to balance your portfolio between appreciation and income, between conservative and aggressive.
Often, investors focus on a particular market cap segment. Some may choose to stick with the big, stable, large-caps — especially if they want to preserve their capital or derive income from their investments. Others may be attracted to the more volatile — and exciting — small-caps, especially if they have a long time horizon to weather volatility or like aggressive growth stocks.
Cutting across industries and industrial sectors, each market cap group encompasses a big variety of companies and stocks. Still, analysts do note common tendencies and characteristics among stocks of similar market caps.
For example, Robert R. Johnson, Professor of Finance at Creighton University, notes that small-caps may be more volatile than mid- and large-caps — but they tend to perform better.
"From 1926 to 2019, large-cap stocks have provided average returns of 10.2% annually; small-cap stocks over the same time period provided annual returns of 11.9%," he says.
It doesn't sound like much in percentage terms. However, "over many years, that difference is enormous: one dollar invested in large-caps at the end of 1925, with dividends reinvested, would have grown to $9,243.90. That same dollar invested in small-caps would have grown to $39,380.90.," Johnson notes.
"The bottom line is that small-cap stocks provide higher returns, on average — but that comes at the cost of greater risk."
Market capitalization vs. market value
You'll sometimes hear "market capitalization" used interchangeably with "market value." But they don't mean the same thing. Whereas market capitalization is a single, easy-to-calculate figure, market value is a more complex, amorphous characteristic that we try to estimate in a number of ways.
As Ryan Maxwell, COO at FirstRate Data, notes, "market value" is a generic term that refers to the value of an investment (such as a company's stock) as determined by a market (usually, the stock market). Reflecting investor sentiment, it might take into account company assets, fundamentals, and other factors.
For example, Maxwell says, a company's enterprise value is another specific measure of a company's market value, one that considers its debt as well as its stock.
Alongside market capitalization and enterprise valuation, investors will often use ratios such as price-to-earnings ratio, price-to-sales ratios, and return on equity to compare values between companies.
"Everyone is working to measure a company's true market value," Asher Rogovy, Chief Investment Officer at Magnifina, says. "Whoever understands the true value can profit by trading mispriced stocks. Market capitalization represents how investors, on average, estimate true market value. It's one indicator of market value and a great starting point for analysis."
The financial takeaway
Market capitalization is a way to measure what a company's worth is. Essentially the collective price of all of a company's outstanding shares, market capitalization tells us about the value that investors put on a company's stock.
And that tells us, indirectly, about what we can expect from the company in terms of returns.
Companies with lower market capitalization values may be riskier but can pay off big. Companies with greater market capitalizations probably will preserve your funds, but may not offer massive gains.
If you're a more conservative investor, you may lean towards large-caps. And if you're looking for more of a gamble, small-caps might be for you. If you want a balance in your portfolio — appreciation plus income — the mid-caps may be the way to go.
Related Coverage in Investing:
What is common stock? The most typical way to invest in a company and profit from its growth
How to diversify your portfolio to limit losses and guard against risk
How to invest in penny stocks: a guide for beginners
Trading and investing are two approaches to playing the stock market that bring their own benefits and risks
What is a stock split, and is it a good or bad sign when it happens?
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Use Market Cap When You're Considering Stocks
When you're evaluating a publicly-traded company and deciding whether you want to purchase some of its stock, you shouldn't focus solely on the price of one share. Make sure you look at its market capitalization, or "market cap," to get a clearer picture of how the market values the company.
The market cap represents the amount you would pay to buy up all of the company's shares, not necessarily its true value. The size of a business's market cap determines the broad category of publicly traded company it falls under—small-cap, mid-cap, or large-cap.
Learn what market cap can tell you about a company and why you should use it when evaluating a one.
What Is Market Cap?
Market cap is the number of outstanding shares multiplied by the current share price. The result tells you the value of a company's stocks on the stock market. It is calculated using the float method or the free-float method.
Float is the number of shares a company has that are outstanding and owned by the public investors. The free-float method doesn't count shares held by executives, a government, or some other private party whose stake is not traded on the market.
Most stock market indexes use free-floating market caps. The Dow Jones Industrial Average and the Standard & Poor's 500 Index are two of them.
Market cap is a company's size on the stock market. If the stock market's total value is $49 billion, and a business has $12.25 billion in outstanding shares, its market cap is one-quarter of the stock market.
Consider these two companies with very different stock prices yet somewhat similar market caps:
- Stock price: $50
- Outstanding shares: 50 million
- Market cap: $50 x 50,000,000 = $2.5 billion
- Stock price: $10
- Outstanding shares: 300 million
- Market cap: $10 x 300,000,000 = $3 billion
If you looked only at their per-share prices, you wouldn't know the second company was the more highly valued of the two. No two investors share the same thoughts on value, because everyone is unique. However, the second company has more shares issued. That means that overall, investors value its shares more highly than those of the first company.
Market Cap Systems
When you're evaluating companies, market cap helps you compare similar businesses. The criteria for small-, mid-, and large-cap companies differ. They also change as the overall market waxes and wanes. Here is an example system:
- Small-Cap:under $1 billion
- Mid-Cap:$1 billion to $10 billion
- Large-Cap:$10 billion or more
On March 17, 2021, Standard & Poor's (S&P) started using these market-cap limits and ranges for its large-, mid-, and small-cap indexes.
- S&P 500: at least $11.8 billion
- S&P MidCap 400: $3.3 billion to $11.8 billion
- S&P SmallCap 600: $750 million to $3.3 billion
Some firms and analysts add micro-caps and mega-caps—the smallest and biggest publicly traded companies—to the mix.
In general, small-cap stocks have greater potential for price growth, because the companies themselves still have room to grow. However, they may also be riskier investments, because future performance is always unknown.
Large-cap stocks have less growth potential but are thought to be safer investments because of their longer success records. Mid-cap stocks typically fall between small caps and large caps for their growth and safety guidelines.
Market Cap vs. Enterprise Value
A company's market cap can also be called its "equity value." The market cap considers only the value of its shares. Enterprise value is a broader way of gauging a company's worth.
To calculate a company's enterprise value, you add its market cap to the value of its outstanding preferred shares (if any) to any minority interest in the company (if any). Then, add in the market value of its debt and subtract its cash and equivalents.
The cash and equivalents are subtracted out, because if you were to buy the company, you would take that money. Therefore, it shouldn't be included when arriving at a theoretical takeover price for the company.
You can use enterprise value instead of market cap in common metrics for evaluating companies. Some examples are price-to-earnings and price-to-sales ratios. Doing so may help you more accurately determine the worth of companies with large cash holdings.
The Balance does not provide tax or investment advice or financial services. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.
Frequently Asked Questions (FAQs)
Why is market cap important?
Market cap is an expression of the total value of a company on the open market—it demonstrates what it's worth to investors. It also gives you an indication of the size of a company and its operations. These factors help you assess the potential risk and return involved in investing in a company.
How does market cap affect stock price?
Market cap doesn't directly affect a company's share price, since market cap is simply the company's total outstanding shares multiplied by its share price. However, since market cap reflects a company's perceived value in the eyes of investors, this can still drive up the share price over time.