A company’s market capitalization, or market cap, provides a good measure of its size and can tell you a lot of important information that can help you build a diversified portfolio.
Market capitalization, commonly known as market cap, is a measure of a company’s value, which is what most investors refer to when they talk about the size of a company.
It 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.
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.
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.
What Is Free-Float Market Cap?
Full market cap is calculated using the total number of outstanding shares, including shares selling on the open market, and also those that may not be available yet. 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 the locked-in shares owned by company insiders and governments. 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, that track stock movements use the free-float method.
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.
Categorizing With Market Cap
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 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 vary by company or stock market index. Here’s how each group is commonly broken down.
Companies with a market cap of $10 billion or more make up this category.. You may hear large cap stocks referred to as blue chip stocks. These companies are typically stable industry leaders and have a proven track record that can make them popular with investors.
The mid cap group comprises companies with a market cap of $2 billion to $10 billion. Mid cap stocks may represent growth stocks on their way to becoming bigger, pricier companies.
As a result of this growth potential, these stocks are considered to be a little bit more risky than their blue chip counterparts.
With a market cap of less than $250 million to $2 billion, small cap stocks typically represent relatively young companies.
There’s growth potential, but these stocks often don’t have a very long track record, so they’re considered riskier than blue chip and mid cap stocks.
Micro cap stocks have a market cap of less than $250 million.
What Market Cap Tells You
When comparing stocks, it can be helpful for investors to compare apples to apples. If an investor were considering investing in a small and relatively new tech startup, it wouldn’t be very helpful to compare it to a tech behemoth.
Understanding the market cap of a company can help investors evaluate the company in the context of other companies of similar size. For example, an investor choosing between auto manufacturing stocks could look at large cap companies in that sector and compare how they are doing against each other.
If one company is significantly underperforming others of a similar size, it can be a clue to dig deeper into what is hurting its value.
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.
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.
Investors can compare large cap companies against the S&P 500 to get a sense of how they are performing relative to a broad swath of their competitors. There are all sorts of indexes that investors can use to compare stocks of different sizes.
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.
Market cap can also 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.
They may be relatively new companies, and the market they are entering may be untested. What’s more, compared to larger companies, they have relatively few resources, such as access to cheaper credit and access to liquidity.
As a result, economic downturns can take a greater toll on them. That said, these companies may offer high long-term growth potential, though investors must be prepared for the possibility of price volatility in the short-term.
Mid cap stocks also potentially offer growth for investors. These companies may be more proven in their respective markets than their small-cap counterparts, and may be actively and successfully increasing their market share.
Mid caps may offer greater stability than small caps and more growth potential than large caps.
Investments in large cap stocks are generally considered to be more conservative than mid and small caps.
These stocks tend to be less volatile than smaller stocks and tend to offer steady returns. Large cap companies tend to be mature and unlikely to offer fast growth. Investors ultimately are deciding between trade growth potential for low risk.
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.
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.
A diversified portfolio might start with an understanding of your personal goals, risk tolerance, and time horizon. Time horizon is the amount of time you are willing to hold their investments until you need your money, and risk tolerance is how willing you are to hold more volatile investments in return for potentially greater returns.
Based on those factors, investors can set an asset allocation that determines what percentage of their portfolio will include stocks. For example, a common portfolio might contain 60% stocks and 40% bonds.
Inside the stock allocation, investors can use the same factors of goals, time horizon, and risk tolerance to determine what mix of stocks to include based on company size and other factors, such as geography and sector. As market shifts occur, portions of this portfolio can behave differently.
For example, as mid cap stocks are on their way up, large cap stocks could be on their way down. In this case, the positive movement of the mid cap stocks has the propensity to temper the negative effects of the large cap stocks.
How to Use Market Cap to Invest
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 exchange-traded funds (ETFs) that seek to mirror the returns of indexes that track stocks based on market cap. You might start by opening an investing account with SoFi. The type of account you open could be determined by your goals.
If you want to buy individual stocks, you might want to consider using an active investing account, which will allow you to handpick stocks that interest you.
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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