The market capitalization of a company is the measure of it’s worth and it’s size. This goes beyond the book value which is the sum of all of it’s liquid assets. Basically a company is worth more than the cash, equipment and other assets it owns. The market cap is the measure of what the market thinks is that valuation of a company.
It is basic market cap calculation is outstanding shares multiplied by share price. For example, if Company A has 1,000 outstanding shares and each share is going for $5 a piece, the market cap would be $5,000 (1,000 X 5 = 5,000).
Cap-Size Types
There are three general categories of cap size, the small, mid and large-cap. You can go even more focused down to nano-cap, micro-cap and mega-cap. But for the sake of discussion, we’ll keep it at the general three. Each cap-size has it’s own investment strategy with both advantages and disadvantages.
Small-cap stocks are companies worth less than $2 billion. Mid-cap stocks have a value between $2-$10 billion and large-caps have capitalizations over $10 billion. Each has it’s own set of risk and reward variables.
The smaller the company gets, the greater potential you would have for higher returns. In the same token, the smaller a company gets, the riskier the investment and more volatile the share price.
The great advantage to small cap stocks is that you generally aren’t betting that much. So if you diversified your money across many small cap stocks, you have a greater chance of finding those few winners that will go on to become the next Google or Microsoft. Or you can let someone else do it by buying into small cap mutual funds. These funds let someone else take care of the risk management for you because investing in these small stocks can be tedius.
Mid-cap stocks are like it’s namesake, somewhere in the middle between risk and reward. They are moderately risky and have moderate room for growth. Generally these companies have sold business models that have clearly worked and so they have a foundation to build into the future. This is something that the small caps are still in the process of doing.
Large-caps are the safest investments. They behave more like bonds than stocks sometimes. These are companies like GE and Exxon Mobil. Gigantic companies with a diversified income stream. They are hard to make fall. And as 2008 proved, sometimes they are too big to fail.