A company's market-cap is a key metric used to evaluate risk and the potential for returns in its stock (2024)

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  • 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 company's market-cap is a key metric used to evaluate risk and the potential for returns in its stock (1)

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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.

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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:

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CategoryMarket value
Micro-cap and nano-capLess than $300 million
Small-cap$300 million to $2 billion
Mid-cap$2 billion to $10 billion
Large-cap and mega-cap$10 billion to $2 trillion-plus

Although no official or legal designations exist, there are generally agreed-upon boundaries for each market-cap category.

What is a small-cap stock?

Small-cap stocks are companies that have a market capitalization value between $300 million and $2 billion. Small-caps are often new companies, focused on a niche market, or struggling financially. While small-caps tend to be volatile and rarely offer dividends, they have a lot of growth potential and are often undervalued.

The following are characteristic of small cap stocks:

  1. They're — you guessed it— little guys.These companies are often limited in size or outreach or both. They may be regional or not yet well-established in the field. That means they have lots of room to grow, but also lots of room to fail. They may also become acquisition targets for larger corporations.
  2. They rarely provide income.Many small-caps don't paydividends, preferring to reinvest their profits back into the company for further growth. They're not a great choice for income investors.
  3. They're volatile.Many small-cap stocks attract excitement — but not a lot of actual investors. Their trading volume is low. That, along with their general lack of track record, means they tend to see large or sudden swings in price.

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Even smaller than small cap stocks, 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.

These are often very risky investments with lots of volatility. Most penny stocks fall into the nano- or micro- categories.

What is a mid-cap stock?

Mid-cap stocks are companies that have a market values between $2 billion and $10 billion. Mid-caps are usually moderately risky but generally stable companies that still have room to expand. Since mid-caps often offer both dividends and price appreciation, they can give investors a balance between income and growth.

While equity analysts, money managers, and stock-picking pundits publish up-to-the-minute data on the performance of both giant corporations and small, up-and-coming companies, you often have to dig for information about the mid-cap enterprises.

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But this category of companies is actually made up of many reputable businesses and they tend to perform relatively well. TheS&P MidCap 400 Index, which tracks 400 middle capitalization companies, has a 10-year annualized return of about 9%, compared with 11% for theS&P 500, which is made up of large-cap stocks mostly with market values of $10 billion or more.

The companies that comprise the mid-cap segment tend to have several characteristics in common.

  1. They're large — but not enormous.These companies are often well-established in their region or in their industry. But they're usually not too big to fail if there is a real threat to the business or if the market for their goods and services dries up.
  2. They often pay dividends.While large-caps get much of the attention from income investors, many mid-caps are doing well enough that they can share profits with stockholders. While they reinvest earnings back into the business, they can also pay out substantialdividends.
  3. They're fairly stable.Mid-caps don't usually have the same diversified business model or access to resources that help large-caps weather economic challenges and stock-market trends. Still, mid-cap companies typically have a track record of steady performance over a significant period of time — often years or decades. In the investment scheme of things, they're of moderate or middle (that word again!) risk.

What is a large-cap stock?

Large-cap stocks are companies that have a market capitalization value of over $10 billion. Large-caps are usually mature, well-established companies that have been consistently successful and pay regular dividends. Though they lack great growth potential, large-caps are a favorite of conservative investors for their steady payouts and prices.

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The companies that make it to the large-cap category tend to have several characteristics in common.

  1. They're transparent. Financial information about these companies is publicly available, as are reams of expert analysis and forecasting. It's easy to find the information you need to make well-informed investment decisions about these companies.
  2. They pay dividends. Because they are so well-established in the market, these companies can commit to relatively high dividends. That means investors can expect consistent income from their company shares — payouts for immediate income or to reinvest back into the company.
  3. They're stable. These are typically companies that have been around a while — decades, even a century — and have weathered some challenging economic conditions. Their operations, earnings, and share prices remain steady, no matter what the stock market overall is doing.

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.

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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.

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"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.

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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 on market capitalization

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.

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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.

Ramsay Lewis

Ramsay is a freelance writer and data analyst atCrisp Analytics. He has worked in the Office of the Chief Economist in Canada's Department of Trade, and has advised on the financial chapters of First Nations treaties when he worked with Indigenous and Northern Affairs Canada. He has a Master's in Public Administration from the University of Victoria and a certificate in Data Science and Big Data from the Federal University of Paraná.

As a seasoned financial expert with a background in data analysis, I've delved into the intricacies of investing, market dynamics, and the evaluation of financial instruments. My expertise extends to various aspects of the investment landscape, from market capitalization to assessing the worth of companies in terms of their stocks.

Market capitalization, commonly referred to as "market-cap," is a fundamental concept in the realm of finance. It represents the total value of a company's outstanding stock, essentially reflecting what it would cost to acquire all its outstanding shares at the current market price. This metric is a powerful indicator of a company's financial strength and provides insights into the associated risks and potential returns.

In the provided article, the author emphasizes the importance of market capitalization in categorizing stocks into different segments, such as large-cap, mid-cap, small-cap, micro-cap, and nano-cap. Each category has distinct characteristics and risk-return profiles, making them suitable for different investment goals and risk tolerances.

For instance, small-cap stocks, with market capitalizations between $300 million and $2 billion, are often associated with new or niche-focused companies that may be struggling financially. Despite their volatility and the rarity of dividends, small-caps offer significant growth potential. On the other end, large-cap stocks, valued over $10 billion, are typically mature, stable companies with consistent success and regular dividend payouts, making them favorable for conservative investors.

The article also touches upon mid-cap stocks, ranging from $2 billion to $10 billion in market capitalization. These companies strike a balance between risk and stability, often providing both dividends and price appreciation. The author notes the performance of the S&P MidCap 400 Index, which tracks mid-cap companies, highlighting their relative stability and a 10-year annualized return of about 9%.

Furthermore, the author discusses the dynamic nature of market capitalization, affected by daily fluctuations in stock prices and changes in the number of outstanding shares due to actions like stock issuances or buybacks.

To reinforce the importance of understanding market capitalization, the article compares the historical returns of different market-cap segments. It notes that while small-cap stocks generally exhibit higher average returns, they come with greater risk compared to large-cap stocks.

The article also distinguishes between market capitalization and market value, clarifying that while market capitalization is a straightforward figure, market value is a more complex concept that investors estimate using various factors, including enterprise value, price-to-earnings ratio, price-to-sales ratios, and return on equity.

In summary, the article provides a comprehensive overview of market capitalization, its significance in evaluating investment options, and how it plays a crucial role in constructing a diversified portfolio based on individual investment preferences and risk appetite.

A company's market-cap is a key metric used to evaluate risk and the potential for returns in its stock (2024)
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