Market Capitalization: What It Is and Why It’s Important

Market capitalization — or market cap — measures a company’s value based on the number of stock shares it has issued and the price at which investors are willing to buy them.
Chris DavisJun 12, 2020
Market Capitalization: What It Is and Why It’s Important-story

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Market capitalization is the total value of all of a company’s shares of stock and is calculated by multiplying the number of stock shares outstanding by the current share price. If a company has issued 10 million shares and its share price is $100, its market cap is $1 billion. Shares outstanding includes all shares — those available to the public and restricted shares available to and held by specific groups.

Market cap allows investors to size up a company based on how valuable the public perceives it to be. The higher the value, the "bigger" the company. Public companies are also grouped based on their size — most commonly, small-cap, mid-cap and large-cap.

The size and value of a company can affect the level of risk you can expect when investing in its stock, as well as how much your investment might return over time. Categorizing companies this way helps investors create a balanced portfolio that's optimized for long-term growth.

Often, market-cap data is also used to manage mutual funds. These funds can hold stock in dozens or even hundreds of companies, which allows investors to buy many stocks in a single transaction. Mutual funds often invest by category, so investors can buy small-cap or large-cap funds.

What is float-adjusted market cap?

Unlike market cap, float-adjusted market cap (sometimes called free-float market cap) is calculated using only shares that are available to the general public, excluding locked-in shares, such as those held by institutions and government agencies.

Many major stock indexes, like the S&P 500 and the Dow Jones Industrial Average, use float-adjusted market cap, as do many index funds and exchange-traded funds, which are types of mutual funds that choose their investments by mirroring a market index. Float-adjusted market cap is meant to give an even more accurate picture of how the market views and values a company’s stock. Explore the specifics of the S&P 500 to learn more about this.

Below is a general guide to the major market-cap segments, but it’s important to remember the threshold isn’t clearly defined; the higher-value components of one segment can mix in with the lower-value segments of the next. Indexes and fund managers may have different definitions of market cap or use wider or narrower criteria. A company’s share price can also fluctuate enough to move it into a higher or lower market-cap category.

Large-cap: Valuation of $10 billion or more

Large-cap companies tend to be those that are well-established and profitable, and are often household names, including:

  • Microsoft Corp.

  • Johnson & Johnson.

  • JPMorgan Chase & Co.

  • Exxon Mobil.

  • General Mills.

  • AutoZone.

Because they’re so established, large-cap companies are generally more stable — they’re reliable in terms of dividend payouts and typically don’t grab headlines the way some flashier stocks might. But this understated nature is actually what makes them attractive to investors, according to Serina Shyu, a certified financial planner with Delta Community Retirement & Investment Services in Atlanta.

"Large-cap stocks are pretty boring, and an investor wants boring in their portfolio," Shyu says. "When things go crazy in the markets, large-cap stock prices might go up or down accordingly, but not as much compared to mid-cap or small-cap stocks."

The annualized 10-year total return of the S&P 100 index — an index of the 100 largest U.S. companies by market cap, including all large-cap stocks — is currently about 14%.

There are several funds that track large-cap stocks, including iShares S&P 100 ETF, Vanguard Value ETF and Schwab U.S. Large-Cap Value ETF. Many brokerages offer tools to screen and discover more funds that track companies with specific market capitalizations.

Mid-cap: $2 billion to $10 billion

If large-cap companies have already seen rapid growth, mid-cap companies are often in the midst of it. With that growth comes the opportunity for higher, faster gains, but also the potential for more drastic downturns. Mid-cap companies are often household names, too, but typically aren’t national — or international — behemoths like the companies above. A few mid-cap stocks include:

  • Boston Beer Company (maker of Samuel Adams).

  • Cracker Barrel.

  • Etsy.

  • Wyndham Hotels and Resorts.

  • Dick’s Sporting Goods.

The annualized 10-year total return of the S&P MidCap 400 is currently about 12%, and there are several funds that seek to mirror similar returns, such as SPDR Portfolio S&P 400 Mid-Cap ETF and Vanguard S&P Mid-Cap 400 ETF.

Small-cap: $250 million to $2 billion

Small-cap stocks are often young companies with the potential for high growth. These stocks may have the possibility of high returns (that small-cap could indeed grow to be a mid- or large-cap) but they also come with the possibility of significant losses.

Small-cap companies typically have only a few revenue streams, depend on overall U.S. economic growth and can feel the effects of taxes and regulations more profoundly than more-established businesses. If large-caps are the big cruise liners that can withstand the stormiest seas, small-caps are the sailboats that can be rocked by a single wave.

Still, the opportunity for growth they present can benefit an investor’s portfolio, provided the potential downside is buoyed by the relative stability of large-cap stocks. Examples of small-cap stocks include:

  • Bed, Bath & Beyond.

  • GoPro.

  • Abercrombie & Fitch.

The Russell 2000 Index, which tracks small-cap companies including all of the above, currently has a 10-year annual return of about 11%. There are several funds that track the Russell 2000, such as iShares Russell 2000 ETF and Vanguard Russell 2000 ETF.

Micro- and mega-cap

There are two other market-cap categories, generally referred to as micro-cap (below $250 million) and mega-cap (the largest companies on the stock market, some of which overlap with large-cap).

Micro-cap stocks are considered some of the riskiest investments. Many have virtually zero track record, and it’s possible they don’t even have any assets, operations or revenue to report. Mega-caps, meanwhile, represent the most established companies that often have large cash reserves that may help them weather economic downturns.

Balancing your portfolio

When it comes to balancing your portfolio between companies with various market caps, Shyu likens it to making everyday decisions — if large-caps are the chain restaurants of the world, small-caps are the local favorites you’ve never heard of but someone recommends.

"Do you want to have Joe's Burgers around the corner or do you want to have McDonald's? There's room for both in the world and there's room for both in a portfolio," Shyu says. "Just make sure you've got the right percentage of each before you lean heavily into one market cap or the other."

Generally, the longer investment horizon you have, the riskier your allocation can be — a longer timeline means more opportunity for your portfolio to recover from volatility. Long-term investors — for example, those saving for retirement that's decades away — could benefit from the potential growth of small- and mid-cap companies and still have time to weather unexpected downturns.

Investors who don’t want to take as much risk may want to root their portfolio in less-volatile large- and mega-caps, with a lower allocation of small- and mid-caps.

Market capitalization vs. enterprise value

There’s one final distinction to understand: Market capitalization isn't the same as a company’s enterprise value. While market cap measures the value of a company’s equity, enterprise value measures the total value of the business, including its debts, assets and cash. Enterprise value is more complicated to calculate, but it also provides an extremely clear picture of what a company is worth.

Enterprise value is mostly used to determine the price of a company if it were to be acquired outright. However, experienced investors can use enterprise value alongside other performance data to determine whether a stock price is currently under- or overvalued relative to similar companies.

» Want to learn more? Read about how to start investing in the stock market

Disclosure: The author held no positions in the aforementioned securities at the original time of publication.

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