Living on what you earn is fine for the short term, but if your goals in life involve having money to retire on – or even just to have fun with in the meantime – it means you'll need to start investing. That requires learning a whole new vocabulary of investment terms, and the concepts that go along with them. One is market capitalization or market cap, which is a basic way of assessing the companies you're researching.
Define Market Capitalization
A lot of the calculations used by investors revolve around complicated math or abstract concepts. Market capitalization isn't one of those. You work out a company's market cap by looking up the number of its outstanding shares and then multiplying that number by the current share price. Effectively what it tells you is how the market currently values the company. You could think of it as a "manufacturer's suggested retail" for public companies. It doesn't tell you what the company is worth, because the market might currently under-value or over-value the company for a variety of reasons. It's still a useful measure, though, because it gives you a rough idea of how large the company is and what resources it has at its disposal.
Market Capitalization Categories
Most sources recognize three main levels of market capitalization: Large-cap for the biggest companies, small-cap for the small companies and mid-cap for those in between. There isn't any industry or government body that defines those terms, and they change over time as the markets continue to climb, but the industry as a whole establishes a broad consensus.
As of 2018, large-cap companies were generally considered to be those with a market value of $10 billion or more, mid-cap companies were those between $2 billion and $10 billion and small-cap companies were those with a value of $250 million to $2 billion. Many investors recognize two more levels, micro-cap for companies valued below $250 million and mega-cap for those valued at over $200 billion.
The Importance of Cap Size
Cap size is an important consideration when you're deciding which companies to invest in because companies with large and small market capitalizations offer distinctly different risks and opportunities. Large-cap companies tend to be well-established entities operating in stable, mature markets. Their pockets are deep enough to stand up to adverse situations, like market downturns or tough competition, without being seriously damaged.
Mid-cap companies are often the up-and-coming firms, the ones who've gotten past their early growing pains and have excellent growth potential. Small-cap companies can be players in niche markets or newly established sectors, or new arrivals in established markets who've found a way to differentiate themselves from more established companies.
Cap Size and Diversification
Most investment strategies revolve heavily around a concept called diversification. The idea is to hold a wide range of different investments so that whether times are good or bad, you'll always have some part of your portfolio that's giving you productive gains. For example, you might have a combination of individual stocks, mutual funds or exchange-traded funds, bonds or maybe even Bitcoin or some other cryptocurrency. You can also diversify within a given category, like stocks. One way to do that is by owning stocks of companies at different levels of market capitalization.
Large-cap companies tend to be safe and stable, offering smaller gains but less risk. Mid-cap companies are more variable but offer the chance for higher growth and more significant returns. Small-cap companies are the riskiest, but that's where you'll sometimes find the kind of long-shot "home run" investments you can brag about for the rest of your life. Walmart and Microsoft were small-cap companies once.
Market Capitalization of Apple
General definitions are fine, but it's often useful to look at specific companies to get a better feel for how large-, mid- and small-cap companies look in the real world. In late 2018, the largest of large-cap companies was tech giant Apple. It had a total of 4.83 billion shares outstanding at around $222, for a total market capitalization of $1.07 trillion. Large-cap companies, in general, are considered to offer limited opportunity for big returns, but tech firms can be an exception.
While it traded at $222 in October of 2018, a share of Apple fetched just under $75 in October of 2013. A more conventional company with a huge market cap is Johnson & Johnson. With 2.68 billion shares trading at around $133, its market capitalization as of October 2018 was $359 billion. Its share price in October 2013 was just over $92, which still represents robust growth, though not in Apple's class. In other words, you can still make good returns on some large-cap stocks, as long as they're the right ones.
Market Capitalization of Foot Locker
An excellent example of a mid-cap company is athletic footwear retailer Foot Locker. As of October 2018, it had over 114 million shares outstanding at a price of approximately $49 per share, for a market cap of $5.7 billion. Retail as a whole has notoriously taken a beating over the past few years, but Foot Locker has held up well, perhaps because with sporting shoes the opportunity to try them in person – as opposed to ordering online – is rather important. In October of 2013, Foot Locker traded at around $37 and had risen to over $49 by October of 2013. That's pretty fair growth, but mid-cap stocks are more volatile. During those five years, shares have been as high as $77 and as low as $30. Depending on when you bought and sold, Foot Locker might have made you a tidy profit or caused you a significant loss.
Market Capitalization of Universal Insurance Holdings
There are relatively few mega-cap companies like Apple, but many more small-cap companies. One good example of a small-cap company is Florida-based Universal Insurance Holdings. It's a relatively small player in the insurance business, with over 34 million shares outstanding at a price of about $45 as of October 2018, for a market cap of $1.57 billion. The company works primarily in homeowner's insurance, with one subsidiary specializing in homes with a value of $1 million or more. It's best established in the Florida market but has expanded operations into several other states in the South, New England and as far north as New York. In October of 2013, its stock traded at just $7.80, so the company's five-year growth has been impressive. The potential for continued growth, or for companies like this to be acquired by larger competitors, is what makes them so appealing to investors willing to face the risks that come with putting their money into smaller companies.
Limitations of Market Capitalization for Investors
Market cap is one of the first things you'll look at before you invest in a company, but it's just one of many figures you'll use. Its value comes early in the process after you've decided on an investment strategy and go looking for companies that fit into the large-, mid- or small-cap categories. Once you've identified interesting companies in each category, for example, you might move on to look at more meaningful indicators such as their dividend yield or their price-to-earnings ratio, commonly abbreviated as P/E. The P/E ratio is just the market cap divided by a year's after-tax earnings, which gives you an indication of the company's profitability. That's a good indicator of continued growth. The dividend yield tells you how much your investment will bring you in dividends, which usually applies to the part of your portfolio that's conservatively invested. How much emphasis you put on this or any other measure of a stock's value, really boils down to your investment goals and the strategy you use to reach them.