General Investing Online Brokerage Account. Life events. Life priorities. Investor education. Tools and calculators. Contact us. Open an account with Merrill. Company size: Why market capitalization matters Share:. Text size: aA aA aA. Stocks represent ownership in companies of various sizes.
Understanding the relationship between company size, return potential, and risk is crucial if you're creating a long-term investment strategy.
With this knowledge, you'll be better prepared to build a balanced stock portfolio that comprises a mix of market caps. Typically, companies are categorized in one of three broad groups based on their size — large-cap, midcap, and small-cap. Cap is short for market capitalization, which is the value of a company on the open market.
To calculate a company's market capitalization, multiply its stock's current price by the total number of outstanding shares.
Generally, market capitalization corresponds to a company's stage in its business development. Typically, investments in large-cap stocks are considered more conservative than investments in small-cap or midcap stocks, potentially posing less risk in exchange for less aggressive growth potential.
Midcap companies may be in the process of increasing market share and improving overall competitiveness. This stage of growth is likely to determine whether a company eventually lives up to its full potential. Midcaps may offer more growth potential. Therefore, midcaps may offer more growth potential than large caps.
Footnote 1. The relatively limited resources of small-cap companies may make their stocks more susceptible to a business or economic downturn, and they could also be vulnerable to the intense competition and uncertainties of untried markets. On the other hand, small-cap stocks may offer significant growth potential to long-term investors who can tolerate volatile stock price swings in the short term.
Footnote 2. Companies sometimes issue additional shares to raise capital or buy back shares. Assuming a constant share price, issuing shares would increase market capitalization and buying them back would decrease it. You'll often hear companies classified in terms of their market capitalization. Based on dollar size, these classifications can also help investors pick the right stocks for their investment goals and risk tolerance.
Although no official or legal designations exist, there are generally agreed-upon boundaries for each market cap category. They are typically less risky investments, given that they're backed by years of stable earnings and stock price performance. However, as mature corporations, they also usually do not grow very quickly. For investors, that means large-cap stocks may bring steady — but not massive — returns.
Most blue-chip stocks are large-caps. They are usually sizable, well-established companies. Some may be familiar names, like American Eagle Outfitters, Lending Tree, and TripAdvisor; others might be less well-known, but are respected and fast-rising in their field, like Peloton or Diamondback Energy.
As their name suggests, mid-caps occupy a middle ground for investors: They may be riskier than large-caps, but are still relatively safe certainly more so than the small-caps, from whose ranks they often spring. Their stock can be more volatile than large-caps', but it also may also have more potential for appreciation, as many of these companies are still actively growing.
Small-cap companies are riskier still. Getting in on the ground floor of a successful small-cap company can be very lucrative — if you guess right. But it may take time for it to pay off, and unlike the large- or mid-caps, it probably won't be providing much in terms of dividends or other returns in the meanwhile.
Smaller companies can be divided even further. These are often very risky investments with lots of volatility. Most penny stocks fall into the nano- or micro- categories. Market cap is an important concept because it allows investors to understand the size of a company and how much its worth on the market. With that growth comes the opportunity for higher, faster gains, but also the potential for more drastic downturns.
A few mid-cap stocks include:. Boston Beer Company maker of Samuel Adams. 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. 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. Examples of small-cap stocks include:. Micro-cap stocks are considered some of the riskiest investments. Mega-caps, meanwhile, represent the most established companies that often have large cash reserves that may help them weather economic downturns.
There's room for both in the world and there's room for both in a portfolio," Shyu says. 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.
These are well established companies that operate in industries which are emerging and forecasting rapid growth. As mid-caps are in the process of expanding, they carry higher risk than large-caps who are inherently more established, but this growth potential is often appealing for investors. These tend to be young companies that serve emerging industries or niche markets, and as such, are considered higher risk investments.
Small caps generally have fewer resources are more sensitive to economic slowdowns and market volatility, and less liquid than more mature and larger companies. Choosing to invest in a large-cap stock is often considered more conservative than investing in a smaller valuation company.
A common method to gauge the performance of an investment is to measure its returns against those of an index containing similar investments. As each market capitalisation category can be affected differently by economic or market developments, over time, large-cap, mid-cap, and small-cap stocks have taken turns leading the market.
Indeed, when large-caps are declining in value, small-caps or mid-caps may be on the way up and could potentially help counteract any losses. The information contained in this article is general information only. Any advice is general advice only.
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