What Is Market Capitalization?
Market capitalization is the market value of a company, determined by multiplying together the number of outstanding shares of the company and the current share price.
The three figures of market capitalization are large caps, mid caps, and small caps. The large cap, or market leader, is a company with a market capitalization of 20 billion U.S. dollars or more. Small caps, on the other hand, are companies with a market capitalization of only 3 billion U.S. dollars or more. In other words, small caps are companies that have high growth potential.
Until a company reaches a cap of 40 billion U.S. dollars, it is classified as a mid cap. Companies with a market capitalization of 40 billion U.S. dollars or more are classified as large caps.
Use the Right Mix to Balance Your Portfolio for the Long Run
If you’ve been investing for any length of time, you know that the market doesn’t go straight up or straight down. When times are good, you can either buy what you want or add to your investment holdings. But when times are bad, you’ve got to be a little more selective. And that’s where diversification comes into play. Diversification is having a mix of investment types and also a mix of sizes (which we’re going to talk about today).
Qualities that Diversification Preserves
Diversification will help preserve the gains you’ve already made. If you’re in a rut and have lost money over the last few years, diversification is one way to find a spot of light.
As an investor, part of what it means to have a well-diversified portfolio is to have small-cap stocks and then to augment that with large-cap stocks.
The Differences Among Small-, Mid- and Large-Cap Stocks
Small-cap — Market Cap Less Than $2 Billion
Small-cap stocks trade on the NASDAQ and the NYSE, but the bulk of the trading volume takes place on the NASDAQ. Small-caps can present unique challenges for novice investors because they are subject to wild swings in price swings and they must withstand the test of time to produce meaningful gains.
The real risk to small-caps is the lack of liquidity. The market may not recognize the true value of an asset and leave it sitting on the shelf for years before absorbing it.
Because of their higher risk profile, investing in small-cap stocks is generally considered to be best suited for investors that are at least 40 years old and have a high risk tolerance.
Small-cap stocks are attractive because they can offer significantly higher returns as compared to large-cap stocks.
Mid-cap — Market Cap From $2 Billion to $10 Billion
Mid-cap stocks are not as common as large-cap or small-cap stocks and, as a result, hold a certain appeal for investors. Not only are mid-cap stocks less expensive per share than large-cap stocks, they also have the potential to offer greater returns. Mid-cap stocks are not as prevalent on most stock exchanges as other companies because their share prices are generally too high for investors with small portfolios. However, mid-cap stocks are known to offer greater growth potential, and the largest mid-cap companies can gain the same type of status as large-cap companies over time.
Large-cap — Market Cap of $10 Billion or More
The large-cap sector is home to some of the most well-known companies in the world. Companies like Walmart, Exxon Mobil, General Electric, and Coca Cola all come to mind. The market cap of a company is simply the price per share multiplied by the number of shares outstanding.
If we take a look at the Dow today, out of the 30 companies you see, 24 of them are large-cap. And out of the four mid-caps, one is a financial company
The great thing about large-cap stocks is that diversification is easy. This simply means that, because there are many companies in this category, there is a good chance that if one goes down, another one will go up.
The market is always efficient. No matter what. And because of this efficiency, if one of the large caps goes down, another one will go up and cancel out the loss. If you were to have 100% of your portfolio in large cap stocks, there’s no telling what could happen.
Why Company Size Is Important
A company of any size can be profitable … but there’s a major difference between smaller and much larger companies. Small companies tend to be more volatile in nature. These can be great for earning quick profits, but they’re also riskier investments.
Small companies have low profit margins and they usually don’t have the resources to expand their offerings or diversify their bottom lines.
As a result, when the economy takes a turn for the worse, these companies are usually impacted before their much larger rivals. Small companies can become distressed, go out of business, or have to take on massive debt in order to survive.
Large companies, on the other hand, have competitive advantages. They have enjoyed some stability thanks to their size, and they’re frequently the last companies to succumb to economic woes.
Large companies employ thousands of people, purchase billions of dollars in supplies, and can simply weather the storm more easily.
In order to take advantage of this stability, diversify your portfolio with both large and small companies. Just a few large caps can bring in a lot of funds, but don’t neglect the rising stars of the small caps market.
The best way to do this safely is by learning about large cap stocks.