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What is market cap in stocks? It’s truly one of the most valuable pieces of information to help predict winning investments. And risk. How market cap could help you find the next big Amazon while it’s still tiny and cheap. And preserve your portfolio from disaster as you plan for retirement.

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What is market cap in stocks

What is market cap when it comes to stocks? Read on to understand this critical factor in choosing winning stocks.

If you’re looking to win in the stock market over the long term, you need to know what market capitalization – or market cap – is. Understanding the relationship of market cap to risk and return is critical to choosing winning investments.

So what exactly is market cap in stocks? Market cap is the aggregate value of all of a company’s shares of stock.

It’s calculated by multiplying the price per share by the number of outstanding shares (the company’s “float”). For example, if a company has 10 million shares outstanding and the share price is $100, its market cap is $1 billion.

The free-float method for calculating market cap excludes any shares held by the company’s executives, government, or any other private entity whose stock is not available for public trading. The Dow Jones Industrial Average and the S&P 500 both use free-float market caps.

Market Cap – a Critical Investment Tool

Market cap is one of the most important tools to help project risk and returns for a company’s stock. It can help you reduce risk. Or potentially find the next big Amazon while it’s still tiny and cheap.

Some investors, especially new investors, make the mistake of thinking share price is the determining factor when it comes to a company’s worth. They may think a higher share price means a more stable company. Or a lower share price is a bargain stock. Stock price isn’t the thing to look at. Market cap is.

Market Cap = Price per Share x Shares Outstanding

The size and value of a company largely determines your risk as a stock investor. It also hints at the return on investment you’ll get over time. And gives you a yardstick for comparing one company to another. Because it says so much, it can help you create a balanced portfolio that’s customized for long-term growth and minimum risk.

Investors break companies into these market cap groupings:

  • Mega-cap – $200 billion+
  • Large-cap – $10 billion to $200 billion
  • Mid-cap – $2 billion to $10 billion
  • Small-cap – $300 million to $2 billion
  • Micro-cap – $50 million to $300 million

Market cap also helps define mutual funds. Mutual funds hold dozens or hundreds of stocks, grouped by market cap size – small-cap, large-cap, etc.

Major Breakdowns by Market Cap Size

Mega-cap – $200 billion+

These behemoths are the market’s largest companies. They’re often household names, long-time players, and leaders in their industries. Apple ($2.39 trillion[i]) and Amazon ($1.62 trillion[ii]) are two big-name mega-caps.

Large-cap – $10 billion to $200 billion

Large-cap companies have earned a reputation for quality goods and services, a history of consistent dividend payments, and predictable growth. They’re dominant players in established industries. Their brand names are nationally known. General Mills ($36.93 billion[iii]) and AutoZone ($25.88 billion[iv]) are examples of large-caps.

Large and mega-caps are also called blue-chips. They’re steady, predictable, and conservative (even boring) investments. As a matter of fact, it’s okay for your investments to be “boring” so the rest of your life can be exciting!

However, all companies (including blue chips) are exposed to some market risk, and therefore can lose money.

Mid-cap – $2 billion to $10 billion

These established companies are more volatile than mega-caps and large-caps. But less volatile than small-caps and micro-caps.

Most mid-caps are growth stocks that have established themselves at least regionally, if not nationally. This growth stage will determine whether they eventually become a large-cap. Yelp is an example of a nationally known mid-cap.

Mid-caps offer more growth potential than mega- and large-caps. And less risk than small-caps.

Small-cap – $300 million to $2 billion

Small-caps are often young companies with potential for high or exponential growth. However, these companies may have only one or a few revenue stream(s). They feel regulatory and market pressures more strongly than larger companies do. They may be able to turn on a dime. But they’re more easily tossed by the wind.

It’s true that the potential for extreme growth could be a godsend to you and your portfolio. But the possibility of equally large losses could keep you awake at night. They can be a darling or a devil.

If you invest in small-caps, hedge your downside with some relatively stable large-cap or mega-cap stocks.

What is market cap in stocks

The smaller the market cap, the greater the risk. Plan (and diversify) accordingly.

Micro-cap – $50 million to $300 million

Micro-caps are mainly penny stocks with limited trading activity. The companies themselves may not have any assets, operations, or revenue. Furthermore, the entire company may consist of just a couple people working on an untested product.

If one of these companies strikes gold, the upward potential is exponential. But if they fail, you could lose every penny.

These are certainly not for the faint-hearted. Don’t put your money in until you’ve done a great deal of research. And never invest money you can’t afford to lose. 

Don’t Confuse Market Cap with Enterprise Value

One key distinction… Market cap is different than enterprise value. Market cap measures the overall value of the company’s stock shares in the stock market. Whereas enterprise value measures the value of the business itself for purposes of buying or selling the company.

Experienced investors may use both numbers in their analysis. But it’s important to realize that they’re two different things.

Planning Your Portfolio with Market Caps

To build your portfolio with a proper mix of small-cap, mid-cap, and large-cap stocks, you need to think about your goals, your risk tolerance, and your timeframe (how long till you need the money?).

When you diversify across various market caps, you reduce your investment risk in any one area. This is true whether you’re investing in mutual funds or individual stocks. Remember that mutual funds are also grouped by market cap size.

Generally, the longer investment horizon you have, the riskier your allocation can be. After all, a longer time horizon gives you more time to recover from volatility. If retirement is decades away, you’d probably benefit from the growth offered by owning some small-caps and mid-caps.

 

 

[i] https://finance.yahoo.com/quote/AAPL?p=AAPL&.tsrc=fin-srch  Accessed January 28, 2021

[ii] https://finance.yahoo.com/quote/AMZN?p=AMZN&.tsrc=fin-srch  Accessed January 28, 2021

[iii] https://finance.yahoo.com/quote/GIS?p=GIS&.tsrc=fin-srch  Accessed January 28, 2021

[iv] https://finance.yahoo.com/quote/AZO?p=AZO&.tsrc=fin-srch  Accessed January 28, 2021

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