- Market capitalization (market-cap) is the total value of all a company’s stock.
- Stocks are often categorized by the size of their market-cap: large-cap, mid-cap, small-cap, or micro-cap.
- An indicator of financial strength, market capitalization suggests how risky a stock is and what kinds of returns it might offer.
A big part of equity investing is trying to figure out what a company is worth. If you can measure a company’s value, you’ll be in a better position to know whether you want to commit your hard-earned capital to its stock.
One of the most common ways to evaluate public companies is by market capitalization, or “market-cap” for short.
What is market capitalization?
Market capitalization is the total value of a company’s outstanding stock. In essence, it’s what it would cost you if you were to buy up all of its outstanding shares at the current share price. It is a way of sizing up the value that investors put on the company. Expressed in dollar figures (or whatever the local currency), it’s made up of two factors: the number of a company’s outstanding shares, and the price of each share.
What makes market capitalization change?
Since it depends directly on a company’s stock price, market capitalization changes every day. As the price of a stock rises, so does the market capitalization, and vice versa.
Changes in the number of outstanding shares also influences market-cap. Companies sometimes issue additional shares to raise capital or buy back shares. Assuming a constant share price, issuing shares would increase market capitalization and buying them back would decrease it.
Market capitalization categories and investment strategies
You’ll often hear companies classified in terms of their market capitalization. Based on dollar size, these classifications can also help investors pick the right stocks for their investment goals and risk tolerance.
The most common market cap categories for stocks include:
Although no official or legal designations exist, there are generally agreed-upon boundaries for each market-cap category.
Micro-cap and nano-cap valuation
Micro-caps are typically companies that have a market capitalization between $50 million and $300 million. Nano-caps are those with a market capitalization below $50 million.
Small-cap companies are risky, but with a market capitalization between $300 million and $2 billion, they can provide opportunities for major appreciation. In fact, these firms are often the darlings of growth-oriented investors. Getting in on the ground floor of a successful small-cap company can be very lucrative — if you guess right. But it may take time for it to pay off, and unlike the large- or mid-caps, it probably won’t be providing much in terms of dividends or other returns in the meanwhile.
Small-cap companies include Neophotonics, Unisys, and Purple Innovation.
Mid-caps have a market capitalization between $2 and $10 billion. They are usually sizable, well-established companies. Some may be familiar names, like American Eagle Outfitters, Lending Tree, and TripAdvisor. Others might be less well-known, but are respected and fast-rising in their field, like Diamondback Energy.
As their name suggests, mid-caps occupy a middle ground for investors. They may be riskier than large-caps, but are still relatively safe (certainly more so than the small-caps, from whose ranks they often spring). Their stock can be more volatile than large-caps’, but it also may also have more potential for appreciation, as many of these companies are still actively growing.
Large-caps have a market capitalization of more than $10 billion. They are are very large companies, usually those with a long history and a household names like Visa, Johnson & Johnson, and Walmart.
They are typically less risky investments, given that they’re backed by years of stable earnings and stock price performance. However, as mature corporations, they also usually do not grow very quickly.
For investors, that means large-cap stocks may bring steady — but not massive — returns. Most blue-chip stocks are large-caps.
On the very upper-end of the large-cap spectrum, companies such as Apple, Amazon, and Micro sft make up a small group commonly referred to as mega-caps. These are companies with market capitalization exceeding $200 billion.
Why is market capitalization important?
Market-cap is an important concept because it allows investors to understand the size of a company and how much its worth on the market. Since companies of different market-cap sizes vary in terms of their growth potential, income payments, and risk, spreading your investments among them is one way to balance your portfolio between appreciation and income, between conservative and aggressive.
Often, investors focus on a particular market-cap segment. Some may choose to stick with the big, stable, large-caps — especially if they want to preserve their capital or derive income from their investments. Others may be attracted to the more volatile — and exciting — small-caps, especially if they have a long time horizon to weather volatility or like aggressive growth stocks.
Cutting across industries and industrial sectors, each market cap group encompasses a big variety of companies and stocks. Still, analysts do note common tendencies and characteristics among stocks of similar market-caps.
For example, Robert R. Johnson, Professor of Finance at Creighton University, notes that small-caps may be more volatile than mid- and large-caps — but they tend to perform better. Large-cap stocks provided average returns of about 10% annually from the early 20th century to the early 21st century, compared with about 12% for small-caps, he says.
It doesn’t sound like much in percentage terms. However, “over many years, that difference is enormous: one dollar invested in large-caps at the end of 1925, with dividends reinvested, would have grown to $9,243.90. That same dollar invested in small-caps would have grown to $39,380.90,” Johnson notes.
“The bottom line is that small-cap stocks provide higher returns, on average — but that comes at the cost of greater risk.”
Market capitalization vs. market value
You’ll sometimes hear “market capitalization” used interchangeably with “market value.” But they don’t mean the same thing. Whereas market capitalization is a single, easy-to-calculate figure, market value is a more complex characteristic that we try to estimate in a number of ways.
As Ryan Maxwell, COO at FirstRate Data, notes, “market value” is a generic term that refers to the value of an investment (such as a company’s stock) as determined by a market (usually, the stock market). Reflecting investor sentiment, it might take into account company assets, fundamentals, and other factors.
For example, Maxwell says, a company’s enterprise value is another specific measure of a company’s market value, one that considers its debt as well as its stock.
Alongside market capitalization and enterprise valuation, investors will often use ratios such as price-to-earnings ratio, price-to-sales ratios, and return on equity to compare values between companies.
“Everyone is working to measure a company’s true market value,” Asher Rogovy, Chief Investment Officer at Magnifina, says. “Whoever understands the true value can profit by trading mispriced stocks. Market capitalization represents how investors, on average, estimate true market value. It’s one indicator of market value and a great starting point for analysis.”
The bottom line
Market capitalization is a way to measure what a company’s worth is. Essentially the collective price of all of a company’s outstanding shares, market capitalization tells us about the value that investors put on a company’s stock. And that tells us, indirectly, about what we can expect from the company in terms of returns.
Companies with lower market capitalization values may be riskier but can pay off big. Companies with greater market capitalizations probably will preserve your funds, but may not offer massive gains.
If you’re a more conservative investor, you may lean toward large-caps. And if you’re looking for more of a gamble, small-caps might be for you. If you want a balance in your portfolio — appreciation plus income — the mid-caps may be the way to go.