A company’s size determined by the total value of its shares is referred to as its market capitalization. To manage return expectations, create a well-balanced portfolio, and make wise investment decisions, market capitalization is a crucial piece of information.
Understanding the total stock value can assist investors in differentiating between high-risk and low-risk investments, as well as in diversifying their holdings under their specific objectives. Large corporations, for instance, might be a better option for an investor with a low-risk tolerance or a portfolio with a short time horizon because they are more stable and offer less potential for return growth. A portion of the data needed to make these choices is provided by market capitalization or market cap.
How market capitalization is calculated
Multiplying the current stock price by the total number of outstanding shares yields the market capitalization of a company. Shares issued and sold to shareholders, including those held by institutional investors and insiders, are referred to as outstanding shares. Treasury shares, or the company’s repurchased shares, are not included in the calculation.
How a company’s market cap is classified
What does it really mean, assuming that Company A has a $10 billion market capitalization? Generally speaking, a company’s size falls into one of three major categories:
- Large-cap: Companies with a market capitalization of $15 billion or more
- Mid-cap: Companies with a market capitalization between $3 billion and $15 billion
- Small-cap: Companies with a market capitalization between $300 million and $3 billion
With a $10 billion market capitalization, Company A in the previous example might be categorized as a mid-cap.
Large-cap stocks are sometimes referred to by investors as mega-caps, while small-cap stocks are sometimes referred to as micro-caps or even nano-caps.
What market capitalization means
A company’s market capitalization frequently provides insight into the strength of the company that underpins the stock as well as the trading patterns of the stock. The main distinctions between small-cap and large-cap stocks are listed below.
Generally speaking, large caps are regarded as reliable businesses with strong balance sheets. When the market is down, these companies usually exhibit less volatility than their mid- and small-cap counterparts.
Among the largest businesses in the world are those with substantial market capitalizations. The large-cap market is dominated by firms like Berkshire Hathaway, Apple, Microsoft, Alphabet, and Amazon. Large-cap businesses are frequently recognized for their ability to produce high-quality products, exhibit consistent growth, and hold a dominant position in well-established markets.
According to Mark Andraos, partner at Regency Wealth Management in New York, “large-cap companies have historically outperformed relative to their small- and mid-cap counterparts in economic downturns, primarily because they represent more established companies with stronger balance sheets.”
Conversely, smaller businesses can present a mixed bag. Even though smaller businesses might have more room for expansion than large-cap firms, investing in them carries a higher risk but also a higher potential reward if they succeed due to their less established position within their industry and typically weaker balance sheets.
Nevertheless, some portfolios do have a place for mid- and small-cap stocks. Within any given industry, there may be one or two dominant players. Sometimes, value can be found with the smaller players, according to Holmes Osborne, principal of Osborne Global Investors in Missouri.
Market capitalization provides an overview of a company’s worth and is a crucial piece of information when making investment decisions. Nonetheless, due to daily stock fluctuations, market capitalization can vary significantly, particularly for smaller businesses.
Merely evaluating a business on the basis of its market capitalization conceals information about the company’s level of debt and any associated risks.
How market capitalization influences investment strategy.
The way you put together an investment portfolio can be impacted by market capitalization. Diversification, or holding a mix of small–, mid-, and large-cap stocks, is typically advised by experts.
“One should generally be diversified across market capitalization and across value/growth to be fully diversified,” states Robert Johnson, the CEO and chair of Economic Index Associates, a New York index development and licensing firm.
For instance, if you want to minimize volatility and concentrate on small-cap stocks, you can also invest in some large-cap firms. Thus, you could mix and match top small-cap ETFs with a few top large-cap ETFs.
“Investing in small-cap stocks increases the probability of hitting a home run significantly, but it also increases the likelihood of a strikeout,” asserts Johnson.
Large-caps are a good choice if stability is your main objective, but you can also add smaller, potentially growing companies to your portfolio to give it some extra vigor.
Investing in mid-cap stocks or the best mid-cap ETFs would allow you to benefit from both higher growth and higher stability compared to large-cap stocks and small-cap stocks. Alternatively, you could split the difference.
However, exercise caution when adding individual stocks to an index fund portfolio, as you may be increasing your exposure to companies that you already own.
Today, the majority of index funds have weights determined by market capitalization. Technology companies like Apple, Microsoft, Google, Amazon, and Tesla make up nearly 20 percent of the S&P 500. According to Doug Amis, CEO of Cardinal Retirement Planning in the Chapel Hill, North Carolina area, “combining a typical market-weighted approach to investing could over-concentrate a portfolio in tech.”
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Then, you can construct a diverse investment portfolio by using your time horizon and risk tolerance as benchmarks.
Comprehending market capitalization is crucial for investment selection as it facilitates the assessment of an investment’s overall potential. But, it doesn’t give investors a complete picture of a company’s potential returns, so they must carefully consider each company when assembling their portfolios.