Market Capitalization

by Paul Ruedi

Though investors can readily look at stock price, or the value of a small portion of a company, the total value of the company or “market capitalization” is often less understood. Market capitalization, or “market cap” for short, is defined as the total number of shares of a company outstanding multiplied by the value of those shares. For example, if company X had a share price of $100 per share and 1 million shares outstanding, it would have a market capitalization of $100 million.

Companies with a market value of over $200 billion are called “mega-cap.” Large capitalization or “large-cap” companies are larger than $10 billion but smaller than $200 billion. Companies worth less than $10 billion but more than $2 billion are considered “mid-cap.” Companies with values below $2 billion but above $250 million are considered “small-cap.” Any company with a market value of less than $250 million is considered “micro-cap.”

You will often see terms like “Large-Cap,” “Small-Cap,” etc. in the titles of different investment funds. If that is the case it is fairly clear what size companies the fund invests in. Other times it is less clear based on the title. The S&P 500, for example, is made up of large and mega-cap companies. The Russell 2000 is made up of small companies. Though many investment funds focus on a particular company size, diversified investment funds often will invest in companies of all sizes.

Market capitalization is important because it is one of the features of a portfolio that determines your expected return. Though you can’t predict the performance of any individual company, academic research has shown that, as a group, smaller companies tend to provide higher returns than larger companies. This makes intuitive sense, as investors feel large companies are a safer investment, and therefore don’t demand as high of a return for investing in them. The excess return small and micro-cap stocks produce over their larger counterparts over time does not show up every year, and should only be expected over long time horizons.

When building the stock portion of your portfolio, it is important to hold all different sizes of companies to be adequately diversified. Investors who only own the S&P 500 may feel diversified, but they are leaving out thousands of other companies in the mid, small, and micro-cap space. If you aren’t sure how to build a diversified stock portfolio that considers the impact of market cap yourself, you may want to talk to a financial advisor.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.