How Market Capitalization Affects Stock Value
You can determine a company’s value (and thus the value of its stock) in many ways. The most basic way is to look at the company’s market value, also known as market capitalization (or market cap). Market capitalization is simply the value you get when you multiply all the outstanding shares of a stock by the price of a single share.
Calculating the market cap is easy; for example, if a company has 1 million shares outstanding and its share price is $10, the market cap is $10 million.
Small cap, mid cap, and large cap aren’t references to headgear; they’re references to how large a company is as measured by its market value. Here are the five basic stock categories of market capitalization:
Micro cap (less than $250 million): These stocks are the smallest, and hence the riskiest, available. (There’s even a subsection of micro cap called nano cap, which refers to stocks under $50 million.)
Small cap ($250 million to $1 billion): These stocks fare better than the micro caps and still have plenty of growth potential. The key word here is “potential.”
Mid cap ($1 billion to $10 billion): For many investors, this category offers a good compromise between small caps and large caps. These stocks have some of the safety of large caps while retaining some of the growth potential of small caps.
Large cap ($10 billion to $50 billion): This category is usually best reserved for conservative stock investors who want steady appreciation with greater safety. Stocks in this category are frequently referred to as blue chips.
Ultra cap (more than $50 billion): These stocks are also called mega caps and obviously refer to companies that are the biggest of the big. Stocks such as Google and Apple are examples.
From a safety point of view, a company’s size and market value do matter. All things being equal, large cap stocks are considered safer than small cap stocks. However, small cap stocks have greater potential for growth.
Compare these stocks to trees: Which tree is sturdier, a giant California redwood or a small oak tree that’s just a year old? In a great storm, the redwood holds up well, whereas the smaller tree has a rough time. But you also have to ask yourself which tree has more opportunity for growth. The redwood may not have much growth left, but the small oak tree has plenty of growth to look forward to.
For beginning investors, comparing market cap to trees isn’t so far-fetched. You want your money to branch out without becoming a sap.
Although market capitalization is important to consider, don’t invest (or not invest) based solely on it. It’s just one measure of value. As a serious investor, you need to look at numerous factors that can help you determine whether any given stock is a good investment.