Mar 10, 2017
Market Capitalization: How to Compare Apples to Apples When Investing
Large-cap, medium-cap, small-cap, what’s the deal with market cap?
Let’s talk capitalization.
Don’t worry, Stash hasn’t diversified into grammar advice, we’re still just your friendly neighborhood fiduciary. We’re talking specifically about market capitalization or market cap.
What is market cap?
The finance world often defines market capitalization as:
The total equity market value of the company is expressed in millions of dollars.
If that’s Greek to you, don’t fret — that’s the jargon. Market cap is one way of understanding what the market thinks the value of a company is. In fact, anyone can calculate the market cap of a company with two numbers:
Total Shares x Share Price = Market Cap
Say there’s a hypothetical company called Pied Piper with 10 total shares and a share price of $30, then its market cap would be 10 shares x $30 share price = $300 market cap.
Let’s talk capitalization.
Don’t worry, Stash hasn’t diversified into grammar advice, we’re still just your friendly neighborhood fiduciary. We’re talking specifically about market capitalization, or market cap.
What’s market cap useful for?
Market cap is a great way to figure out how big a company is. There’s a common misconception that share price represents the size of a company; however, as you now know, share price is only half of the equation.
Let’s say we also have another hypothetical company called Stark Industries with 100 total shares and a share price of $10. This means that Stark Industries has a total market cap of $1,000 (100 shares x $10 share price).
If we compare just the stock prices of Pied Piper and Stark Industries, we may think that Pied Piper, with a $30 share price, is more valuable than Stark Industries with a $10 share price. The reality is that Stark Industries is actually over three times as valuable as Pied Piper ($1,000 vs. $300), because its value is spread across more shares (100 shares vs. 10 shares).
That’s why we need market cap — it’s an easy way to compare apples to apples.
Large-cap, mid-cap, small-Cap
Here’s why cap size matters.
Diversification is key to smart investing. One way to diversify is by buying companies with different market caps.
Companies are generally divided into large-cap, mid-cap, and small-cap. By structuring your portfolio to have a little of each, you’ll have exposure to their different return and risk profiles.
For example, as a general guideline, smaller companies tend to be riskier than their larger counterparts. Smaller companies tend to have less cash, operating history, and available information to investors. A larger company is likely to have the opposite traits, more cash, a more storied operating history, and years of available information. Generally, this translates to greater liquidity but less of a chance for wild growth.
That’s where diversification comes in. You can use the large-cap stocks to balance out the volatility that comes with investing in small-cap stocks. This way, you will have exposure to high-growth small-cap companies, while rooting your portfolio in the more reliable large-cap players.
That being said, you should always make sure to do your own research before investing. The above can serve as a guideline, but it is definitely not the rule.
What kind of money are we talking here?
Opinions differ and can be somewhat flexible on this, but some general guidelines for sizing are:
- Large Cap: $10B+
- Medium Cap: $2B – $10B
- Small Cap: $250M – $2B
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