Last week, we went through the Lady Macbeth Strategy, a concept whose origins lie in classic Shakespearean literature but has some very interesting applications to the world of finance. This week, we will move on to M: Market Capitalization. We have heard of this term all the time, but what exactly is Market Capitalization and why is it important? So, here is our Finance A to Z for this week with the letter M for Market Capitalization!
What Is Market Capitalization?
Market capitalization, also known as "market cap," is the total market value of an organisation expressed in dollars. It is typically calculated using the market value of all of an organisation's outstanding shares of stock. For instance, if a corporation had 10 million shares trading at $20 each, its market capitalization would be $200 million.
If you're constructing an investing strategy intended to assist you in pursuing long-term financial goals, it's imperative that you comprehend the significance of market caps. Market capitalizations provide vital information on the correlation between company size, potential returns and risk. Additionally, it allows investors to gauge a company's size in relation to other companies and to assess a company's worth based on how the general public views it. Investors can learn about the level of risk to be anticipated when purchasing a company's stock from its size and value, as well as the possible long-term return on their investment.
Market Capitalization Categories
Companies can generally be divided into one of three categories when it comes to market capitalization: large cap, mid cap and small cap.
The first of these, large cap, are usually companies with a valuation of at least $10 billion. Large-cap companies frequently have an established record of reliable dividend payments, sustained growth, and the production of high-quality products and services. In addition to their brand name being recognised by a nationwide consumer audience, they are generally also dominating players within well-established industries. Investments in large-cap stocks may therefore be regarded as more conservative than those in small- or mid-cap firms, possibly posing lower risk in exchange for less aggressive growth potential.
With a capitalization between $2 billion and $10 billion, mid cap corporations are smaller than large cap companies. Similar to how mid-cap equities sometimes fall between giant corporations and small caps on the risk/return spectrum. These are often well-established companies in industries that are expanding quickly or are expected to do so in the near future. These mid-sized businesses may also be attempting to increase their overall competitiveness and market share. This stage of growth might decide whether a business ever reaches its full potential. Mid-caps not only have less danger than small-caps, but they also have more room for growth than large-caps.
Last but not least, the value range for small-cap enterprises is typically $300 million to $2 billion. These are often small, specialised businesses that serve emerging markets. Due to their relative lack of resources, small businesses are thought to be the most aggressive and risky of the three market cap categories since they may be more vulnerable to a business or economic downturn. While the high rivalry and uncertainty that mark fresh, developing markets may put small cap firms at risk, long-term investors may discover that small-cap equities offer significant growth potential.
In rarer cases, companies may fit in none of these categories. The mega cap category, for example, consists of a small, elite group of companies with a market cap exceeding $200 billion. Apple and Microsoft are good examples. Conversely, the micro cap category is home to companies with a valuation between $50 million and $300 million.
Using Market Caps to Build Your Own Portfolio
To have a strong investment portfolio, diversification is crucial. Thus, diversifying your investments among businesses with different market caps may help to lower the risk in any one area and aid in the achievement of your long-term financial objectives. The key is to assess your financial objectives, risk tolerance, and time horizon in order to create a portfolio that is properly balanced between small-cap, mid-cap, and large-cap stocks!
That’s all for this week’s submission. Thank you for reading, and be sure to leave any thoughts below in the comments!