Sometimes, investment terminology is tossed around without really being explained…large-cap, small-cap, mid-cap - what exactly do they mean? The investment article published here is intended to help you get down to basics with a series of articles about the different asset classes.
First of all, let's define asset classes. They're the categories that your different investments fall into - basic ones include cash, bonds, large-cap stocks, small-cap stocks, and international stocks, though there are a number of other more specific permutations. Studies have shown that the key to successful investing is to spread your wealth among different asset classes.
Market capitalization is a term used on Wall Street that is extremely important. Although it is often heard on the nightly news and in financial textbooks, very few new investors know what market capitalization is or how it is calculated. It’s actually really easy and intuitive. After you read about the details of market cap, as it is often called for short, you’ll understand the concept and begin using it when putting together your own portfolio.
Put simply, market capitalization is the amount of money it would cost if you were to buy every single share of stock a company had issued at the current market price. For instance, The Coca-Cola Company has 2,317,441,658 shares of stock outstanding and the stock closed at $49.60 per share. If you wanted to buy every single share of Coca-Cola stock in the world, it would cost you 2,317,441,658 shares x $49.60 = $114,945,106,236.80. That’s just shy of $115 billion. On Wall Street, people would refer to Coca-Cola’s market capitalization as $115 billion.
Why is market capitalization such an important concept? It allows investors to understand the relative size of one company versus another. AutoZone, a retailer of auto parts, trades at $150.31 per share. Yet, the company’s market capitalization is only $8 billion. Despite having a stock price 3x higher than Coke, AutoZone is actually only 6.9% the size of the soft drink giant! There you can know How to Think About Share Price. In that article, you could have learn that it’s possible for a $300 stock to be cheaper than a $10 stock.
Traditionally, companies were divided into large-cap, mid-cap, and small-cap.[2] Market capitalization (or market cap) is the total value of the issued shares of a publicly traded company; it is equal to the share price times the number of shares outstanding.[2][3] Market capitalization ranks stocks into a number of distinct groups. This is important when considering an investment in a particular company.
To review, market capitalization (market cap) is a measure of the size and value of a company. To determine market cap, you simply multiply the number of the company's outstanding shares of stock by the market price of one share.
For example, let's say a company has 50,000,000 shares outstanding, and each share is currently selling for $50. The company's market cap would be 50,000,000 multiplied by $50, which equals $2.5 billion.
And why is market capitalization important? Because history has shown us that the stocks of companies with different market caps behave differently in terms of return and risk.
Because large-cap stocks have shown outstanding performance recently, you may have heard that investing in them would have been your best bet. But do large-cap stocks ALWAYS perform better than mid-cap and small-cap? Let's take a look.
Each rank has certain stereotypical features that you can look for in the stock under consideration. Mid cap stocks are more risky than large cap stocks and less risky than small cap stocks. As outstanding stock is bought and sold in public markets, capitalization could be used as a proxy for the public opinion of a company's net worth and is a determining factor in some forms of stock valuation.
The terms mega-cap and micro-cap have also since come into common use,[6][7] and nano-cap is sometimes heard. Different numbers are used by different indexes;[8] there is no official definition of, or full consensus agreement about, the exact cutoff values. The cutoffs may be defined as percentiles rather than in nominal dollars. The definitions expressed in nominal dollars need to be adjusted over the decades due to inflation, population change, and overall market valuation (for example, $1 billion was a large market cap in 1950, but it is not very large now), and they may be different for different countries. A rule of thumb may look like:
Now that we understand what market cap means, let's talk about the performance of different-sized-market cap stocks. We know that over the past few years, large-cap stocks have performed very well. For the ten years ended June 30, 1999, large-cap stocks, as measured by the S&P 500, returned an average of 18.78% per year. Mid-cap stocks, as measured by the S&P 400, returned an average of 17.87% per year for the same period. And small-cap stocks, as measured by the Russell 2000, had average annual returns of 12.39% for the same time period. So, it's easy to see that in the last decade, large-cap stocks performed the best out of these three groups.
Generally, risk of company failure decreases as the company increases in size. However, a mid cap stock also has better potential for growth than a large cap company. A very large company may have completely saturated its market, while a mid-sized company may have room to grow. So when considering an investment, you are basically trying to decide if the stock in question has the potential to grow into a large cap stock. If you are right and make the investment, you will have a successful investment.
The Shortcomings of Market Capitalization
There are some shortcomings to using market capitalization as a guide to a company’s size. The biggest is that market capitalization does not factor into consideration a company’s debt. In other words, in addition to having $115 billion in stock market value, Coca-Cola has $20 billion in debt. If you were to buy every share of Coke’s stock, you would own the company but still be responsible for the company’s $20 billion in debt. Thus, your “true” purchase price would be $115 billion + $20 billion = $135 billion. This figure is known as enterprise value and I explained everything you need to know about it in the article Enterprise Value – Determining the Takeover Value of a Company. There are actually some other factors that determine the difference between market capitalization and enterprise value so if you’re interested in the details, it would be worth your time to click over to those articles and take a few moments to read them.
Using Market Capitalization to Build a Portfolio
A lot professional investors divide their portfolio by market capitalization size. This approach, they believe, allows them to take advantage of the fact that smaller companies have historically grown faster but larger companies have more stability and pay fatter dividends.
Here is a breakdown of the type of market capitalization categories you are likely to see referenced when you begin investing:
First of all, let's define asset classes. They're the categories that your different investments fall into - basic ones include cash, bonds, large-cap stocks, small-cap stocks, and international stocks, though there are a number of other more specific permutations. Studies have shown that the key to successful investing is to spread your wealth among different asset classes.
Market capitalization is a term used on Wall Street that is extremely important. Although it is often heard on the nightly news and in financial textbooks, very few new investors know what market capitalization is or how it is calculated. It’s actually really easy and intuitive. After you read about the details of market cap, as it is often called for short, you’ll understand the concept and begin using it when putting together your own portfolio.
Put simply, market capitalization is the amount of money it would cost if you were to buy every single share of stock a company had issued at the current market price. For instance, The Coca-Cola Company has 2,317,441,658 shares of stock outstanding and the stock closed at $49.60 per share. If you wanted to buy every single share of Coca-Cola stock in the world, it would cost you 2,317,441,658 shares x $49.60 = $114,945,106,236.80. That’s just shy of $115 billion. On Wall Street, people would refer to Coca-Cola’s market capitalization as $115 billion.
Why is market capitalization such an important concept? It allows investors to understand the relative size of one company versus another. AutoZone, a retailer of auto parts, trades at $150.31 per share. Yet, the company’s market capitalization is only $8 billion. Despite having a stock price 3x higher than Coke, AutoZone is actually only 6.9% the size of the soft drink giant! There you can know How to Think About Share Price. In that article, you could have learn that it’s possible for a $300 stock to be cheaper than a $10 stock.
Traditionally, companies were divided into large-cap, mid-cap, and small-cap.[2] Market capitalization (or market cap) is the total value of the issued shares of a publicly traded company; it is equal to the share price times the number of shares outstanding.[2][3] Market capitalization ranks stocks into a number of distinct groups. This is important when considering an investment in a particular company.
To review, market capitalization (market cap) is a measure of the size and value of a company. To determine market cap, you simply multiply the number of the company's outstanding shares of stock by the market price of one share.
For example, let's say a company has 50,000,000 shares outstanding, and each share is currently selling for $50. The company's market cap would be 50,000,000 multiplied by $50, which equals $2.5 billion.
And why is market capitalization important? Because history has shown us that the stocks of companies with different market caps behave differently in terms of return and risk.
Because large-cap stocks have shown outstanding performance recently, you may have heard that investing in them would have been your best bet. But do large-cap stocks ALWAYS perform better than mid-cap and small-cap? Let's take a look.
Each rank has certain stereotypical features that you can look for in the stock under consideration. Mid cap stocks are more risky than large cap stocks and less risky than small cap stocks. As outstanding stock is bought and sold in public markets, capitalization could be used as a proxy for the public opinion of a company's net worth and is a determining factor in some forms of stock valuation.
The terms mega-cap and micro-cap have also since come into common use,[6][7] and nano-cap is sometimes heard. Different numbers are used by different indexes;[8] there is no official definition of, or full consensus agreement about, the exact cutoff values. The cutoffs may be defined as percentiles rather than in nominal dollars. The definitions expressed in nominal dollars need to be adjusted over the decades due to inflation, population change, and overall market valuation (for example, $1 billion was a large market cap in 1950, but it is not very large now), and they may be different for different countries. A rule of thumb may look like:
- Mega-cap: Over $200 billion
- Large-cap: Over $10 billion
- Mid-cap: $2 billion–$10 billion
- Small-cap: $250 million–$2 billion
- Micro-cap: $50 million-$250 million
- Nano-cap: Below $50 million
Now that we understand what market cap means, let's talk about the performance of different-sized-market cap stocks. We know that over the past few years, large-cap stocks have performed very well. For the ten years ended June 30, 1999, large-cap stocks, as measured by the S&P 500, returned an average of 18.78% per year. Mid-cap stocks, as measured by the S&P 400, returned an average of 17.87% per year for the same period. And small-cap stocks, as measured by the Russell 2000, had average annual returns of 12.39% for the same time period. So, it's easy to see that in the last decade, large-cap stocks performed the best out of these three groups.
Generally, risk of company failure decreases as the company increases in size. However, a mid cap stock also has better potential for growth than a large cap company. A very large company may have completely saturated its market, while a mid-sized company may have room to grow. So when considering an investment, you are basically trying to decide if the stock in question has the potential to grow into a large cap stock. If you are right and make the investment, you will have a successful investment.
The Shortcomings of Market Capitalization
There are some shortcomings to using market capitalization as a guide to a company’s size. The biggest is that market capitalization does not factor into consideration a company’s debt. In other words, in addition to having $115 billion in stock market value, Coca-Cola has $20 billion in debt. If you were to buy every share of Coke’s stock, you would own the company but still be responsible for the company’s $20 billion in debt. Thus, your “true” purchase price would be $115 billion + $20 billion = $135 billion. This figure is known as enterprise value and I explained everything you need to know about it in the article Enterprise Value – Determining the Takeover Value of a Company. There are actually some other factors that determine the difference between market capitalization and enterprise value so if you’re interested in the details, it would be worth your time to click over to those articles and take a few moments to read them.
Using Market Capitalization to Build a Portfolio
A lot professional investors divide their portfolio by market capitalization size. This approach, they believe, allows them to take advantage of the fact that smaller companies have historically grown faster but larger companies have more stability and pay fatter dividends.
Here is a breakdown of the type of market capitalization categories you are likely to see referenced when you begin investing:
- Micro Cap: The term micro cap refers to a company with a market capitalization of less than $300 million.
- Small Cap: The term small cap refers to a company with a market capitalization of $300 million to $2 billion.
- Mid Cap: The term mid cap refers to a company with a market capitalization of $2 billion to $10 billion.
- Large Cap: The term large cap refers to a company with a market capitalization of $10 billion to $50 billion.
- Mega Cap: The term mega cap refers to a company with a market capitalization of $50 billion or more.
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