A company’s market capitalization, or market cap, provides a good measure of its value and can be used to build a diversified portfolio.
Market cap represents the value of the total number of outstanding shares. It’s an important figure to consider when comparing similar companies or considering future growth expectations. Here’s a closer look at this metric.
How To Calculate Market Cap
To figure out a company’s market cap, all you need to do is multiply the number of outstanding shares by the current price per share. If a company has 10 million outstanding shares of stock selling for $30 per share, the company’s market cap is $300 million.
Share prices fluctuate constantly, and as a result, so does market cap. You should be able to find the number of outstanding shares listed on a company’s balance sheet, where it’s referred to as “capital stock.” Companies update this number on their quarterly filings with the Securities and Exchange Commission (SEC).
In some cases, market cap can change if the number of stocks increases or decreases. For example, a company may issue new stock or even buy some back. When a company issues shares, the stock price may dip as investors worry about dilution.
Recommended: Understanding Stock Dilution
Stock splits do not increase market share, because the price of the stock is also split proportionally. Changes to the number of shares are relatively rare, however. More commonly, investors will notice that changes in share price have the most frequent impact on changing market cap.
Market Cap Versus Stock Price
If you’re new to investing, you may assume a company’s share price is the clearest indicator of how large a company is. You may even assume it’s as important in choosing a stock as market cap.
While the share price of a company tells you how much it costs to own a piece of the company, it doesn’t really give you any hints as to the size of the company or how much the company is worth.
Market cap, on the other hand, might give you some hints about how a particular stock might behave. For example, large companies may be more stable and experience less volatility than their smaller counterparts.
There are many thousands of companies investors can buy shares in, and the values of publicly traded companies can range widely from a few million dollars up to a trillion dollars or more.
To help investors keep track of all of this information, stocks are categorized into various buckets, including by market cap.
Analysts, as well as index and exchange-traded fund (ETF) providers, commonly sort stocks into small-, mid-, and large-cap stocks, though some include a broader range that goes from micro cap stocks on the small end all the way to mega cap on the large end. The size limits of these categories can change depending on market conditions but here are some rough parameters.
|Market Cap||Dollar Size||Examples with Ticker|
|Micro-cap||$50 million to $300 million||Neurobo Pharmaceuticals (NRBO), American Realty Investors Inc. (ARL)|
|Small-cap||$300 million to $2 billion||Bonanza Creek Energy Inc. (BCEI), Hostess Brands (TWNK)|
|Mid-cap||$2 billion to $10 billion||Urban Outfitters Inc. (URBN), Amyris Inc. (AMRS)|
|Large-cap||$10 billion or higher||Delta Air Lines Inc. (DAL), Gilead Sciences Inc. (GILD)|
|Mega-cap||$200 billion or higher||Tesla Inc. (TSLA), Coca-Cola Co. (KO)|
Recommended: Pros & Cons of Buying Mid-cap Stocks
Evaluate Stocks Using Market Cap
Understanding the market cap of a company can help investors evaluate the company in the context of other companies of similar size.
For instance, market cap can clue investors into stocks’ potential risk and reward, in part because the size of a company can be related to where that company is in its business development. Typically, small cap stocks are considered to be riskier investments.
Investors can also evaluate how a company is doing by comparing its performance to an index that tracks other companies of a similar size, a process known as benchmarking.
The S&P 500, a common benchmark, is a market cap weighted index of the 500 largest publicly traded U.S. companies. The S&P MidCap 400, for example, is a market cap weighted index that tracks mid cap stocks. The Russell 2000 is a common benchmark index for small cap stocks.
Within this system, companies with higher market cap make up a greater proportion of the index. You may often hear the S&P 500 used as a proxy for how the stock market is doing on the whole.
What Market Cap Can Tell You
Here are some characteristics of larger market-cap companies versus smaller-cap stocks:
Volatility: Larger companies, also often dubbed blue-chip stocks, tend to be less volatile than smaller stocks and tend to offer steady returns. What’s more, compared to larger companies, they have relatively few resources, such as access to cheaper credit and access to liquidity.
Revenue: Larger stocks tend to have more international exposure when it comes to their sales and revenue streams. Meanwhile, smaller stocks can be more oriented to the domestic economy.
Growth: Smaller companies tend to have better odds of offering faster growth.
Valuation: Larger stocks tend to be more expensive than smaller ones and have higher valuations when it comes to metrics like price-to-earnings ratios.
Dividends: Many investors are also drawn to large cap stocks because companies of this size frequently pay out dividends. When reinvested, these dividends can be a powerful driver of growth inside investor portfolios.
Market Cap and Diversification
So how do you use market cap to help build a portfolio? Market cap can help you choose stocks that could help you diversify.
Building a diversified portfolio made up of a broad mix of investments is a strategy that can help mitigate risk. That’s because different types of investments perform differently over time and depending on market conditions. This idea applies to stock from companies of varying sizes, as well. Depending on market conditions, small, medium, and large cap companies could each beat the market or trail behind.
Because large-cap companies tend to have more international exposure, they might be doing well when the global economy is showing signs of strength. On the flip side, because small-cap companies tend to have greater domestic exposure, they might do well when the U.S. economy is expected to be robust.
Recommended: Guide to Investing in International Stocks
Meanwhile, larger-cap companies could also be outperforming when there’s a downturn, because they may have more cash at hand and prove to be resilient. In recent years, the biggest companies in the U.S. have been linked to the technology. Therefore, picking by market cap can have an impact on what kind of sectors are in an investor’s portfolio as well.
What Is Free-Float Market Cap?
Float is the number of outstanding shares that are available for trading by the public. Therefore, free-float market cap is calculating market cap but excluding locked-in shares, typically those held by company executives.
For example, it’s common for companies to provide employees with stock options or restricted stock units as part of their compensation package. These become available to employees according to a vesting schedule. Before vesting, employees typically don’t have access to these shares and can’t sell them on the open market.
The free-float method of calculating market cap excludes shares that are not available on the open market, such as these that were awarded as part of compensation packages. As a result, the free-float calculation can be much smaller than the full market cap calculation.
However, this method could be considered to be a better way to understand market cap because it provides a more accurate representation of the movement of stocks that are currently in play. Many of the major indexes, such as the S&P 500 and the MSCI indices, use the free-float method.
Market Cap vs. Enterprise Value
While market cap is the total value of shares outstanding, enterprise value includes any debt that the company has. Enterprise value also looks at the whole value of a company, rather than just the equity value.
Here is the formula for enterprise value (EV):
Market cap + market value of debt – cash and equivalents.
A more extended version of EV is here:
Common shares + preferred shares + market value of debt + minority interest – cash and equivalents.
Investors can use market cap to help them choose individual stocks by comparing like stocks and looking at them in relation to an appropriate benchmark index.
However, building an entire portfolio through individual stocks can also be a time-consuming and potentially tricky endeavor for the average investor as they try to maintain a balanced portfolio. Luckily, there’s a way to outsource some of this work.
Investors have the option to buy mutual funds and ETFs that seek to mirror the returns of indexes that track stocks based on market cap.
You might start by opening a SoFi Invest® account. The Active Investing account allows you to buy individual stocks, ETFs and fractional shares. If you’re more of a hands-off type of investor, you might want to consider using an Automated Investing account. Accounts like these invest in funds that are already diversified across factors such as market cap.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.