Market Capitalization

Introduction

What is market capitalization? Market capitalization, or market cap for short, is basically how much a company is worth. It’s calculated by multiplying the price of each share by the number of shares. If you think about this, it should make sense. Each share represents a part of the company, so by adding up the price of all of them, which is what we’re doing, we should get the total value of the company, sort of like how combining every slice of a pie gets you the whole pie.

Importance

Market cap is one of the most commonly-used metrics when analyzing companies, since it tells us the size of the company. Large, well-known companies typically have large market caps, while newer, smaller companies usually have lower ones. Let’s dive into the classifications for market cap.

Large Cap

These are the largest companies. As always, the definition varies, but the most popular one is a company with a market cap of at least $10 billion. That’s a lot. And many companies out there are much larger than that. For example, right now, Apple is chilling at well over $2 trillion, which is mind-blowingly large. Large caps will typically be your safest companies, since they are well-established. Most blue chip stocks are large cap. As a result, though, the growth potential for these stocks is often not as high because they are already so big.

Mid Cap

These companies, you might be able to guess, aren’t too large and aren’t too small. The most popular definition is a company with a market cap between $2 billion and $10 billion. These companies usually aren’t as large and well-known as the large caps, but they still have made a name for themselves. $2 billion is nothing to scoff at. These typically are riskier than large caps since they aren’t as stable as the big boys, but in return offer more growth potential, since many have more room for upwards movement.

Small Cap

As you might have guessed, small caps are the smallest companies. These are commonly defined as having a market cap lower than $2 billion. They are your rookies. Young and eager for blood. Or going bankrupt. Small caps are the riskiest of them all, since they are so small. Many small caps have enormous potential for growth. In fact, many large mutual funds out there have funds that only contain small caps, and they are typically the best performing funds. However, small caps are also very risky. Oftentimes, the market cap is low because the company is not doing well, causing the price to plummet. It’s hard to make it big as a company, and even promising small caps can fail.

Strategy

For a really strong portfolio, you should have a rough idea of how much to allocate to each market cap size. It all depends on your risk tolerance. I’d say a typical investor should allocate about 60% to large caps, 25% to mid caps, and 15% to small caps. However, if you can’t risk losing much money, cut down on the mid and small caps and allocate more to large caps. It’s totally okay to have an entire portfolio full of large caps. And remember, when investing in mid and small caps, DO YOUR RESEARCH. Research is important for large caps, but especially important for the smaller companies. Good luck!

Sources

Investopedia: https://www.investopedia.com/terms/m/marketcapitalization.asp