Market Cap As A Metric For Picking Stocks: What You Need To Know

Magnifying glass and documents with analytics data lying on table,selective focusMagnifying glass and documents with analytics data lying on table,selective focus

Market cap (or market capitalization) is a term frequently used by investors to reference the total market value of a company’s outstanding shares. While that can sound a little bit complicated, it really just means that many investors typically look at the number of stock shares that a company has outstanding (meaning those that are being held by shareholders) and multiply that number by the current market price of one share. For instance, if McDonald’s had 10 shares outstanding and each share is currently selling at a price of $100, its market cap would be $1000. This sounds inconsequential, but by analyzing this number, investors can actually understand a lot about both a company’s business and size, which might help them to make their investment decisions down the road.

One of the most influential metrics that investors use when considering market capitalization is the ranking system. In fact, you have likely heard some of the ranking terms used before. For example, is the company a large-cap company? Mid-cap? Or could it be small-cap? Many of us hear these terms from day to day, but do not really know what they imply. In reality, these classifications can signify information about the stability of a company and its stock. How? Allow us to explain.

Basically, these classifications come from a variety of criteria used for ranking different companies, but the most important factor is the company’s market capitalization. If a company has a market capitalization of $10 billion or more, it is typically called a large-cap company. If the company’s market cap is between $2 billion and $10 billion, it is usually ranked as a mid-cap company. Lastly, if a company has more than $300 million, but less than $2 billion, it is probably considered a small-cap company. These are the three most common classifications – and the ones that you are most likely to hear as an investor – although there are several other classifications for companies with significantly smaller or significantly higher market caps.

However, the most important information for investors is not only the company’s classification but what that classification really implies. The first assumption that we can typically make when evaluating these rankings is that large-cap companies are companies that have been around for a long time. Why? Well, if they have more money or more available shares, we can assume that the company is very well-known or trusted. For this reason, these companies are usually seen to be “safer” investments – institutions, such as Apple and Google. Much of the time, investors even expect these stocks to be less volatile than other options, because they are companies that have become staples for many consumers.

Following that same line of thought, investors can usually expect mid-cap companies to be less institutional and more in the market for growth. These could be companies in industries that are extremely popular at the moment – such as technology or renewable materials. While the stocks of these companies may be seen as a little bit riskier compared to the more renowned and well-known large-cap companies, many investors still look at mid-cap companies as having great investment potential.

Finally, because of the smaller numbers of shares or prices that small-cap companies are listing, investors typically assume that small-cap companies are very young. This is oftentimes a fair assumption. However, many people falsely assume that these companies are “unstable” because they are young when in reality this is not always the case. While it is true that younger companies may be more sensitive to economic pressures, or more likely to appeal only to niche markets, it is certainly not true that small-cap companies are always risky investments for this reason. In fact, many of these companies have immense potential to grow. So, while investing in small-cap companies may typically be riskier than investing in large-cap companies, you may find it helpful to conduct your own independent research before determining that these companies are poor investment choices.

Ultimately, from looking at a company’s market cap and classification, investors can understand more about the size of the company and the structure of its stock offerings. This can help us to weigh our stock picking decisions and compare different options against each other. Just as we always say, the more metrics you understand, the more informed your stock picking decisions will be!