Dylan Lewis: Hey, there! I'm Dylan Lewis from The Motley Fool. In this FAQ video, we are breaking
down market capitalization and explaining how investors can use it to help them identify companies to invest in.
The finance and investing industry loves to
come up with more complicated ways to say pretty simple things and market capitalization
is a perfect example of that. You'll often hear it abbreviated as market cap, and really
all this number does is tell you what a publicly-traded company is worth.
To find it, just take the number of shares of stock a company has issued and multiply
it by the current market price of the stock. So, if a company has issued a total of 20
million shares and each share is valued at $20, then the company's total market cap is
$400 million. You can do this math on your own, but if you go and search any publicly-traded
company, the market cap will be listed right there, saving you the hassle.
Market cap is one of the best measures of a company's size and it can tell you a lot
about what to expect if you're buying a stock. In general, large companies tend to have more
stable and mature businesses. And having proven themselves over time and weathered difficult
business conditions, they are able to emerge even stronger. However, the growth prospects
for these large companies tend to be more limited, because they've already grown so
much and see so much of the opportunity in front of them. By contrast, smaller companies
have a lot more room to grow. However, smaller companies tend to be riskier and younger with
business models that haven't been proven out over time. Their odds of failure are significantly
higher than those of the more stable, large companies.
Here's a quick breakdown of the way market capitalization ranges are often segmented
and discussed within the stock market.
We're going to explore these categories more in-depth.
But first, let's just appreciate how wide a spectrum we're working with here.
A large-cap company could be 200 to 4,000 times the size of a micro-cap business and
some mega cap companies are worth over $1 trillion.
Large-cap stocks have market capitalizations
of $10 billion or more. Most of the best-known companies in the world are large-caps.
And some investors break out stocks with market caps of more than $200 billion into a separate
category: mega cap stocks. Most large-cap companies have mature businesses and generate
substantial amounts of revenue. They often earn significant profits and have a considerable
market share within their industries, making them leaders in their fields. They are also
more likely than smaller companies to pay sizable dividends to their shareholders, because
their businesses tend to produce greater amounts of available cash. But large-cap companies
have already gone through their period of maximum growth. As a result, even successful
large-cap companies that pay healthy dividends and whose shares have gone up in value consistently,
won't always be able to match the massive returns that smaller companies can achieve.
The trade-off is that investors enjoy more stability and often, market-leading companies
continue to win, they might just not put up insane growth rates.
Mid-cap stocks have market caps in the range of $2 billion to $10 billion, occupying the
middle ground between large and small-cap companies. Mid-cap companies are large enough
to have made considerable progress in building up successful business models and that gives
their investors some stability and protection against future challenges that the company
will face. However, they're small enough that they still give investors a longer runway
for future growth than a large-cap stock. That said, mid-caps also face the difficult
task of trying to catch up and surpass their larger rivals in their industries and they
often don't have as many financial resources to do so.
It's important when investing in mid-cap stocks to know their history. Some mid-cap companies
are still in their high growth phase, while others have reached their full potential in
a relatively small, niche industry of limited size. Still others are older companies that
used to be large-caps, but have had their businesses lose steam. Any of these can be
good investments under the right circumstances, but they have very different characteristics
in terms of growth potential, dividend income and valuation. If you're looking in the mid-cap
space, ideally, you're buying companies that are still posting impressive growth and gaining
market share. Those are the kinds of businesses that ultimately become large-cap companies
and reward shareholders along the way.
Small-cap stocks have market capitalizations
of between $300 million and $2 billion. Some people also include within this category even
smaller companies with market caps of $50 million to $300 million, while others put
those tiny stocks into a separate group called micro-cap stocks. Small-cap companies tend
to be younger than large-caps or mid-caps and they also have a much shorter operating
history as a business. Small-caps often have considerable growth potential, but investors
in small-caps face a lot more uncertainty about their future. In many cases, small-caps
have to append much larger competitors in order to stake their claim within a given industry.
And for every small company that succeeds, many fail.
Over time, small-cap stocks have historically produced higher average returns than large-cap
stocks but their performance has been more volatile along the way. That requires small-cap
investors to have a greater risk tolerance than those who concentrate on larger stocks.
Those with long-time horizons can typically weather the ups-and-downs of small-cap stocks
and therefore have a better chance of enjoying the rewards of greater returns.
Most investors find that having a diversified portfolio that includes large-cap, mid-cap
and small-cap stocks lets them tailor their desired return and risk levels to their specific
wishes. If you want your portfolio little bit more stable then you want a larger allocation
to large-cap stocks. Those who want greater amounts of current income will also typically
gravitate to large-cap stocks, because they tend to be the dividend payers. By contrast,
if you don't need much income and your primary goal is to have your portfolio grow as much
as it can over many years, then you'll likely want to make larger investments in small and
mid-cap stocks. Market cap helps us categorize companies and
it also helps us compare them apples-to-apples. Say, you have two companies, Dillon Enterprises
and Lewis LLC. Dillon Enterprises has a stock price of $30 and shares of Lewis LLC trade
for $20. Now, which one is the more valuable company? You can't know without also knowing
how many shares each company has outstanding. Say, Dillon Enterprises has 10 million shares
outstanding and Lewis LLC has 20 million shares outstanding. Lewis LLC is actually a bigger
company even though its share price is lower, it just happens to have sliced up ownership
of the business more ways. That's why market cap is a far better indication of where a
company sits than share price, and why it's important to know the size of a business you're
buying, before you buy it. If you're looking for more awesome investing
content, check out our free investing starter kit. It covers everything you need to know
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