Market capitalization, commonly known as market cap, is calculated by multiplying a company’s outstanding shares by the company’s stock price per share. A company’s stock price by itself does not tell you much about the total value or size of a company; a company whose stock price is $60 is not necessarily worth more than a company whose stock price is $25. For example, a company with a stock price of $60 and 100 million shares outstanding (a market cap of $6 billion) is actually smaller in size than a company with a stock price of $25 and 500 million shares outstanding (a market cap of $12.5 billion).
Market capitalization categories.
Publicly traded companies are typically grouped into three different market cap categories: large cap, mid cap, and small cap. Not everyone agrees on the same market cap cutoffs for each category, but the categories are often described as follows:
What are large-cap stocks?
Large caps are typically defined as companies with market caps that are $10 billion or above. Included within large caps are mega caps, which are typically defined as companies with markets caps of $200 billion or above. These tend to be companies that are very stable and dominate their industry. Wal-Mart, the world’s largest retailer, is an example of a mega-cap stock. Large-cap and mega-cap stocks tend to hold up better in recessions, but they also tend to underperform small-cap stocks when the economy emerges from a recession. Large-cap and mega-cap stocks tend to be less volatile than mid-cap and small-cap stocks and are therefore considered less risky.
What is a mid-cap stock?
Mid caps are typically defined as companies with market caps that are between $2 billion and $10 billion. Mid-cap stocks tend to be riskier than large-cap stocks but less risky than small-cap stocks. Mid-cap stocks, however, tend to offer more growth potential than large-cap stocks.
What are small-cap stocks?
Small caps are typically defined as companies with market caps that are less than $2 billion. Many small caps are young companies with significant growth potential. However, the risk of failure is greater with small-cap stocks than with large-cap and mid-cap stocks. As a result, small-cap stocks tend to be the more volatile (and therefore riskier) than large-cap and mid-cap stocks. Historically, small-cap stocks have typically underperformed large-cap stocks during recessions but have outperformed large-cap stocks as the economy has emerged from recessions.
The smallest stocks of the small caps are called micro-cap and nano-cap stocks.
Micro-cap stocks ($50 million to $2 billion in market capitalization) and nano-cap stocks (market caps less than $50 million) are even riskier than small-cap stocks. While the opportunity for these companies to experience extreme growth is great, the risk to lose a large amount of money is also possible.
Market capitalization and your portfolio.
Since it’s rarely possible to know exactly when the market will favor large cap, mid-cap, or small-cap stocks, it’s a good idea to include a mix of different sized stocks in your portfolio. An investor with a long time horizon, who is willing to take on more risk in exchange for higher potential returns, may want to hold a larger allocation of small-cap and mid-cap stocks. An investor with a shorter time horizon, who is looking for less volatile stock returns or for stocks that will provide more stable dividends, may want to hold a larger allocation of large-cap stocks. Our investment advisors can help build a portfolio that is appropriate for your given risk tolerance, time horizon, and financial goals.
Mutual funds and market cap.
Mutual funds that invest in stocks are typically categorized as large-cap, mid-cap, or small-cap funds. A mutual fund that is described as a large-cap fund is usually invested mainly in large-cap stocks. However, it is important to understand that not all mutual funds remain true to their categorizations. A large-cap fund may also invest in small cap stocks and other riskier types of securities. When you buy a fund that is categorized as a large-cap fund, you may be buying some securities that aren’t large-cap stocks, thus introducing more risk to your portfolio than you intended. Our research team is able to identify what is actually in a mutual fund’s portfolio and determine which funds are right for your investment portfolio.