Key Takeaways:
Market capitalization, otherwise known as market cap, is a relatively simple investing metric used to evaluate publicly traded stocks. Alone, it can help investors gain a better perspective on a particular business. As a complement to a more comprehensive research strategy, however, the market cap can help investors elevate their portfolios to an entirely new level, which begs the question: What is market cap? Outside of a simple valuation tool, how can the market cap of a stock help investors better understand the equities they are investing in? To answer all of the questions you may have, let’s first define a market cap.
What Is Market Cap?
Market cap is an investment term used to describe the market value of a publicly-traded stock’s outstanding shares. In other words, the market cap is essentially how much it would cost to purchase every share of a company at its current price. The market cap is a very rough estimate of how much a company is worth, which begs the question: What does the market cap tell investors?
Quite literally, the market cap reveals a company’s value. However, the metric serves multiple purposes. Identifying the market value of a publicly traded stock’s outstanding shares gives investors insight into how big the company is, its growth prospects, how much capital it may have to deploy, and how risky an investment it represents.
To be clear, a company’s market cap is a flawed indicator; it’s not meant to be used by itself. Looking solely at the market cap will give investors an idea of how much a company is worth, but it fails to account for debt and locked-in shares held by executives. Therefore, it is better to view a company’s market cap as a complement to other metrics. Only once all the metrics are accounted for will the market cap begin to tell a better story.
How To Calculate Market Cap
To calculate a company’s market cap, investors need access to two variables: the number of outstanding shares and how much they are currently trading for. With these two variables in hand, all that’s required of investors is multiplying the price per share by the number of outstanding shares. As an equation, calculating a company’s market cap will look something like this:
Market Cap = Price Per Share X Shares Outstanding
It’s not enough to know the answer to the question “what is market cap.” Instead, investors need to simultaneously calculate the company’s market cap and translate what it means for future prospects.
Market Cap Vs. Enterprise Value
A stock’s market cap reflects the value of a company’s equity and nothing more. In its simplest form, a market cap is essentially the total value of every share issued by a respective company. By accounting for each share (and its value), investors can simultaneously compare the size of companies, mitigate risk, and estimate potential returns. However, it is important to note that the market cap does not account for anything else other than the value of a company’s equity. On the other hand, enterprise value accounts for the value of a company’s equity and its debt. As a result, the enterprise value is slightly more telling of a company’s true financial standing.
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Types Of Capitalization
The market cap metric is used to place a more tangible value on individual stocks. However, as you are most likely already aware, companies range in value, from tens of millions of dollars to trillions. Thus, the spectrum of stock valuations is vast, with many investors asking a simple question: What is a good market cap? The answer is simple: there is no answer. While large market caps typically represent stability and proof of concept, smaller market caps have room to run. Therefore, a good market cap is simply determined by what you are looking for out of your investments.
For a better idea of the stocks you may want to add to your own portfolio, here’s a list of the types of capitalization investors will want to consider on Wall Street, from largest to smallest:
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Mega-Cap
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Large-Cap
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Mid-Cap
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Small-Cap
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Micro-Cap
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Nano-Cap
Mega-Cap
Aptly named, mega-cap stocks are far and away the largest companies (by market value) traded on today’s major indices, but what is a market cap for a company lucky enough to fit in this category? The traditional definition of a mega-cap stock is a business with a market cap of $200 billion or more. Not surprisingly, mega-cap stocks are rare company, as only a limited number of businesses are even capable of achieving such a high level of market capitalization.
For context, the following meg-cap stocks make up somewhere in the neighborhood of 20% of total market capitalization of the S&P 500:
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Apple Inc. (NASDAQ: AAPL): $2.165 trillion market cap
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Microsoft Corporation (NASDAQ: MSFT): $1.881 trillion market cap
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Amazon, Inc. (NASDAQ: AMZN): $1.667 trillion market cap
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Alphabet Inc. (NASDAQ: GOOG): $1.581 trillion market cap
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Facebook, Inc. (NASDAQ: FB): $907.404 billion market cap
Large-Cap
Following in the footsteps of today’s mega-cap companies, large-cap stocks are those with a market cap between $10 billion to $200 billion. While still considered “blue chip,” large caps can vary significantly in market value. Some of the “smallest” large-cap stocks may hover around $10 billion; the largest ones, however, can border on their mega-cap counterparts. It is worth noting, however, that large-cap stocks aren’t synonymous with growth. At this point, stocks tend to level out, and investors are more attracted to their stability than growth trajectory. That’s not to say large-cap stocks can’t also be growth stocks, but rather that growth in this area is typically the exception and not the rule.
Some of the most popular large-cap stocks include, but are not limited to:
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Starbucks Corporation (NASDAQ: SBUX): $135.198 billion market cap
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MercadoLibre, Inc. (NASDAQ: MELI): $72.103 billion market cap
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Chipotle Mexican Grill, Inc. (NYSE: CMG): $39.732 billion market cap
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Booking Holdings Inc. (NASDAQ: BKNG): $93.573 billion market cap
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Zillow Group, Inc. (NASDAQ: Z): $28.27 billion market cap
Mid-Cap
The market capitalization of mid-cap stocks ranges from $2 billion to $10 billion. Much smaller than both large- and mega-cap stocks, mid-cap businesses are typically nationally recognized. That said, while mid-cap stocks don’t carry the same market value as the previous businesses listed above, they tend to have more room to grow. If, for nothing else, the larger a company’s market cap, the more difficult time it will have growing. Of course, not all mid-caps increase in value; some are more susceptible to declines. Since mid-cap stocks aren’t as established as larger companies, they are more volatile.
Mid-cap stocks most people are familiar with include, but are not limited to:
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Dropbox, Inc. (NASDAQ: DBX): $9.882 billion market cap
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Ralph Lauren Corporation (NYSE: RL): $9.798 billion market cap
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Kohl’s Corporation (NYSE: KSS): $9.501 billion market cap
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ADT Inc. (NYSE: ADT): $7.898 billion market cap
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Mattel, Inc. (NASDAQ: MAT): $7.774 billion market cap
Small-Cap
More often than not, small-cap stocks are relatively new to the market. Since they haven’t had much time to establish themselves (or their revenues), small-cap stocks typically reside within the $300 million to $2 billion market value range. As with recent IPOs (initial public offerings), small caps tend to have a lot of growth potential. After all, there’s only one way to go once you start at the bottom. With the growth opportunity, however, comes a lot of risk. Without an established foundation to build off of (and oftentimes no revenue), small caps can also be very risky.
Some of the most familiar small-cap stocks in today’s market include:
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The Cheesecake Factory Incorporated (NASDAQ: CAKE): $2.894 billion market cap
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Yelp Inc. (NYSE: YELP): $2.869 billion market cap
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iRobot Corporation (NASDAQ: IRBT): $2.796 billion market cap
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Boise Cascade Company (NYSE: BCC): $2.767 billion market cap
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Jack in the Box Inc. (NASDAQ: JACK): $2.73 billion market cap
Micro-Cap
The term micro-cap is typically reserved for what investors call “penny stocks.” As their names suggest, penny stocks denote businesses with market caps that range from $50 million to $300 million. Consequently, micro caps are usually small startups with a lot to prove. Oftentimes, new biotech companies with speculative products or pharmaceutical companies developing a new drug fall under the micro-cap category. For what it’s worth, most are speculative because they haven’t proven themselves yet. However, the decision to go public suggests something is in the works. Either way, these stocks are highly volatile, and more will fail than succeed. Those that make it to the small-cap category, however, boast incredible upside.
Nano-Cap
Nano caps denote businesses with market caps below $50 million and can usually be found “over the counter.” Not surprisingly, nano caps represent the smallest companies with the smallest market valuations. However, as the least valuable businesses, nano caps represent the ultimate “high-risk/high-reward” play in the market. Not unlike their micro-cap counterparts, nano caps are incredibly risky because they haven’t proven anything to investors (some don’t even have a product or revenue). However, there’s always the chance a nano-cap stock pulls through and realizes its true potential. Investors who bet on the right nano caps stand to reap a lot of rewards, but real winners in this category are few and far between.
Why Is Market Cap Important?
The market cap of an individual company helps investors gauge how the stock market as a whole views the respective business. In other words, the market value is how Wall Street perceives the value of public companies. That’s an important distinction to make, as far too many new investors choose to value stocks based on the price of their individual shares. Through no fault of their own, inexperienced investors are led to believe that the higher a stock’s price, the better it is; that’s simply not true. In fact, valuing a company based on its stock price is reckless and ill-advised. Instead, the market cap will give investors a better idea of how to gauge the company’s true value. The market cap is one of the ways investors find undervalued stocks to invest in.
While evaluating a stock based on its market cap will give investors a better idea of how much the company is worth, the real benefit of a sizable market cap is the capital a business may put to use. Typically, companies with larger market caps have more money to deploy, increasing the likelihood of receiving positive sentiment on Wall Street. Therein lies the real benefit of a large market cap: Investors want to invest in companies who can grow and exceed expectations. The market cap is generally used to gauge how prepared a company may grow by investing in itself.
However, it is worth noting that while the market cap is an important metric to consider, it’s only a compliment to an entire suite of indicators that must be acknowledged. If for nothing else, the market cap alone is indicative of nothing. It is not until the market cap is combined with other research that it becomes more telling. On that note, what does a market cap tell you? First, let’s take a look at the benefits of market caps.
Benefits Of Market Cap
The benefits of accounting for a company’s market cap are as plentiful as investors choose to make them. If for nothing else, the market cap will reveal as much about a company as the investor is willing to research. Without much effort, the market cap will uncover the market value of a publicly-traded stock’s outstanding shares; that’s for everyone to see. However, those who apply the market cap to a more comprehensive strategy may reveal a lot more about a business. Specifically, the market cap identifies how much people are willing to pay for a respective company. Identifying market sentiment behind the cap can shed some light on a stock’s future prospects. The higher the valuation, the more likely the business has capital to deploy and invest in itself, leading to a brighter future.
Risks Of Market Cap
The risks of looking at a company’s market cap all have to do with investors’ own due diligence. The market cap itself is of no threat to investors, but misinterpreting it can be dangerous. In particular, those who take a company’s market cap as gospel will quickly learn it’s not meant to tell the whole story. In fact, the market cap only provides a rough estimation of the company’s value and fails to account for everything. Since the market cap doesn’t consider debt, it can certainly be misleading, so investors need to make sure they are looking at the market cap to complement larger strategies.
Summary
What is market cap, if not for a valuable metric used to evaluate publicly traded stocks? When used correctly, the market cap cannot only evaluate individual stocks, but it can also help build a better portfolio. Diversifying a portfolio with a proper mix of small-cap, mid-cap, and large-cap stocks can help investors meet their own financial goals and mitigate risk accordingly. Of course, to do so, you’ll need to be able to differentiate between each type of market capitalization. Now that you have a better idea of what types of market caps exist on Wall Street and how they impact a company’s performance, you should be able to optimize your own portfolio.
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