Market capitalization (frequently shortened to market cap) represents the value of all of a company’s equity and is calculated by taking the number of shares outstanding and multiplying it by the current share price of a public company.
For example, a company that has 10 million shares that sell for $100 each would have a market cap of $1 billion. Given that stock prices fluctuate on a day-to-day basis, a company’s market cap will move up and down with changes in the stock price.
Investors use market cap as a measure of a company’s size. In general, companies with a market cap over $10 billion are considered large-cap companies; mid-cap companies are from $3 billion to $10 billion; and companies under $3 billion are small-cap.
Typically, the larger a company’s market cap, the more established it is in its business development. Large-cap stocks tend to be less volatile and often have a long history by which to analyze the company’s performance. For example, Apple is the largest company in the S&P 500 Index with a market cap of $581 billion as of August 31, 2016.
Mid-cap companies also tend to be established companies, but with more growth potential than their larger counterparts. Therefore, they historically have experienced more growth than large-caps but with more volatility in their stock prices.
Lastly, small-cap companies are companies with smaller market caps. They can be newer businesses, but more importantly, they have the ability to grow at a faster pace compared to their larger peers. Remember, all large companies such as Apple, Google or Home Depot started as small companies. However, along with the greatest growth potential comes a much higher degree of risk.
Jemma Everyday Wisdom: A well-balanced portfolio will generally have exposure to companies of all market capitalizations to be able to capture the growth potential of small companies while reducing their higher risk profile with larger companies.