The stock market is full of jargon. Some terms are fairly easy to figure out. “Buy” and “sell” are simple enough, as are “opening price” and “closing price.”
But others, like “market cap,” are more difficult to suss out. What does “market cap” mean?
Market capitalization, or “market cap,” is the market value of a stock. Understanding market capitalization can help investors assess whether it’s worth investing in a stock.
Related: 6 real questions about investing— answered
What Is Market Capitalization?
A company’s market capitalization is the total value of all its shares of stock. There’s a simple market capitalization formula. Multiply the individual share price by the total number of shares, including both shares that are already owned and ones that are up for grabs.
For example: Wonka Candy Co. à la “Willy Wonka and the Chocolate Factory” is a publicly-traded company. There are 10 million shares of Wonka Candy Co. selling at $100 each. Using the market capitalization formula, multiply 10 million by $100, and Wonka Candy Co.’s market cap is $1 billion.
Market capitalization might seem like a trivial number at first glance. But it helps investors understand a stock’s value.
Careful — don’t confuse “stock value” with “stock price.” Stock price, often referred to as share price, is the price of one share of stock. Wonka Candy Co.’s stock price is $100. A “stock price” on its own doesn’t tell you anything about the value of a company.
A stock’s value is more complex. Investors look at several factors to determine whether they think it’s worth it to buy the stock. Calculating market capitalization is the quickest, simplest way to assess a company’s stock value.
Large-Cap vs. Mid-Cap vs. Small-Cap Companies
There are three main types of companies in the stock market: large-cap, mid-cap, and small-cap.
Novice investors might assume large-cap companies are good, mid are OK and small are bad. But market capitalization isn’t like a box of chocolates; bigger isn’t necessarily better. It all depends on what people want out of their investments.
And it may be wise to consider not putting all your eggs in one type of market cap basket. Many experts recommend people diversify their portfolios by investing in a mixture of the three, as they all involve various levels of risk.
(And even portfolio diversification doesn’t provide a total buffer from risk — in investing, there’s always risk. Instead, it may mitigate risk somewhat.)
Large-Cap Companies
Large-cap companies have a market capitalization of $10 billion or more. They’re usually large companies with established reputations.
Investing in a large-cap company is a more conservative investment. These companies generally have big businesses, access to capital, and are household names, so generally can withstand bumps better than their smaller counterparts.
People can slowly earn money from investing in large-cap companies, but they probably won’t see gains quickly or aggressively as it’s much harder for a large company to double in size every year relative to a smaller company. Here is a full list of large-cap companies.
These are all well-established companies that may be safer investments than smaller companies. Large-cap companies may be a good choice for investors who want less risk and more stability in their stock market holdings.
Mid-Cap Companies
Mid-cap companies’ market capitalization falls between $2 billion and $10 billion. These companies come in all shapes and sizes.
Many are established but don’t offer as many business lines as large-cap companies. Others are in fields that are either already growing rapidly or are expected to grow in the future.
For example, Papa John’s International (PZZA) is a mid-cap company. It’s a well-known corporation, but its share volume is less than 100,000, while large-cap company Johnson & Johnson’s share volume is more than 1 million. This means that mid-cap companies can be less liquid than larger companies.
Mid-cap companies have the potential to grow more quickly and aggressively than large-cap companies, but they aren’t as risky as small-cap companies. They may be ideal for investors who want a balance. They also may be a good choice for diversification, as the companies are both more stable and have the potential opportunity to grow more quickly than larger companies.
Small-Cap Companies
Small-cap companies’ market capitalization ranges from $300 million to $2 billion. These are often small and/or young companies, and their industries are just starting to hit the scene or are niche.
Investing in small-cap companies often involves a lot of risk. They may earn money aggressively… but they can lose money just as quickly. They might struggle due to limited resources, upcoming competition, or economic downturns.
But if a small-cap company performs well, investors stand to potentially make a lot of money. This is one reason experts recommend diversifying and periodically rebalancing your portfolio.
These companies are much more niche than a conglomerate that owns a bunch of companies, like Procter & Gamble. They’re also less established than these companies.
What Impacts a Company’s Market Capitalization?
Market capitalization is the product of a company’s share price and its total number of shares, so it only makes sense that market capitalization increases or decreases as a company’s share price does.
So, the real question might be, “What affects the share price?”
Supply and demand is a huge factor determining share price.
Supply and demand can be affected by internal factors, such as if a company’s net revenue increases or decreases from one quarter to the next. Some experts argue that external factors and the stock market as a whole have more influence on supply and demand, though.
For example, if a similar company in the same industry tanks, due to a scandal, the first company’s stock might also drop, simply because it’s “guilty by association.”
People might assume that the market capitalization also changes if the number of outstanding shares increases or decreases, but that isn’t always the case. The number of shares changes when a company engages in a stock split or a reverse stock split.
If shares are becoming too expensive for people to purchase, the company splits the stocks to create more shares at a lower price. If prices are too low to meet listing requirements, they’ll do a reverse stock split so there are fewer shares at a higher price.
Because the share price changes along with the number of stocks during a split or reverse split, these won’t affect the market capitalization.
Thinking about Investing?
Now that you understand market capitalization, you may have a better idea of the types of companies you want to invest in. You’ve begun your journey—but you still have plenty of decisions to make.
Before deciding whether you want to invest in mutual funds, exchange-traded funds, individual stocks, crypto or fractions of stocks, you can think about whether you want to engage in active or passive investing.
Learn more:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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