Money & Career

Market capitalization and what it means for investors

Author: Canadian Living

Money & Career

Market capitalization and what it means for investors

People choose certain stocks for many different reasons. Often, investors like where a business is located; they might think it's in a strong sector, or hope a company's new gadget will be the next revolutionary product. Some investors, however, choose what to buy based on company size, or market capitalization.

There are three categories of market capitalization, or "market cap," and all have different characteristics. Even if size doesn't matter to you, it's important to know how a small company versus a big one will affect your portfolio. Here's a market cap primer.

What is market capitalization?
A company's "market cap" is the market value of its outstanding shares (those held by investors). To figure this out, just multiply the stock price with the number of shares outstanding. Apple, for example, has 929 million shares outstanding. Multiply that with its stock price -- $397 at the time of writing -- and you get a market cap of about $369 billion. The market cap is the main way investors measure the size of a company.

Leaning on large-caps
Large-cap stocks -- usually, companies with a market cap of $5 billion or more -- are, generally, the safest investments. These are major global conglomerates. They do business in multiple countries and have built up a stable base of customers.

This category usually performs the best during a recession because stock prices of huge companies typically fall less. Worried investors often buy these stable companies during a downturn -- they're safer than smaller-sized businesses -- which also keeps stock prices from falling too much. Over the long run, investors will see some stock appreciation, but they shouldn't expect any major growth.

Sizzling with small-caps
Small-caps are companies with a market cap of between $250 million and $1 billion. These are small businesses -- often start-ups or young operations -- with a ton of growth potential. In fact, that's the main reason people invest in the small-cap space: They want their money to grow significantly. If it all works out, returns could be huge.

Buying a small, unknown tech business that either creates a hot product or gets bought by another company such as Google could result in serious returns. But the opposite can happen, too -- and often it does. Sincae these companies are so new, they can go bust. It's why during a recession, the small-cap space does much worse than large-caps. People get scared so they dump their risky companies and buy big ones. When the economy is strong, small-caps usually outperform large-caps, because investors are willing to take on more risk. Only buy small-caps if you have a high risk tolerance.

Maintaining with medium-caps
If you want a combination of growth and safety, consider medium-caps. These companies have a market cap of between $1 billion and $5 billion and they usually have some characteristics of both small-cap and large-cap companies. If you only care about growth, you'll likely want smaller companies; if you want to play it safe, then buy larger businesses. If you're willing to take on some risk, but don't want the potential of losing everything, then pick up some medium-cap stocks.

There are other market cap classifications -- micro-cap for the really small companies and mega-cap for the huge ones -- but most businesses fall into these three baskets. The size of company you'll want to buy should depend on your risk tolerance and on how much you want your money to grow. Some people invest across all sizes for balance -- the stable businesses protect capital, while the small ones grow it.


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Money & Career

Market capitalization and what it means for investors