With Market Capitalization, Size Matters
~ By Herb White, CFP®, MBA ~
It’s easy to lose sight of portfolio basics, especially if it’s been a while since you sat down and took a good hard look at your investments. But based on my experience, it’s the basics that keep your portfolio purring. One such strategy that may be taken for granted is to structure your portfolio with a mix of market caps. Since diversification can play an important role when structuring portfolios, market caps may help provide that diversification.
What is market cap?
Market cap (aka market capitalization) is a way to compare two or more companies that you may want to invest in. By comparing the market cap of each, you typically get an indication of how they relate to each other in size, and you also get a measure of the companies’ worth on the open market. This helps you compare the future prospects of different-sized companies as well, since it shows what investors generally are willing to pay for their stocks.
How do I figure out a company’s market cap?
Check the company’s quarterly or annual report. Market capitalization is calculated by multiplying the price of a stock by its total number of outstanding shares. For example, a company with 50 million shares selling at $30 a share would have a market cap of $1.5 billion. This example is a small-cap company.
In your comparison of companies, you will find those that are mega-caps, large-caps, mid-caps, small-caps and micro-caps. Large-cap companies, for instance, have a market value of $10 billion or more. Mid-cap companies typically have a market value between $2 billion and $10 billion. And so on.
How do I use market capitalization to select companies to invest in?
Although there are no hard and fast rules, my experience has shown that in general the larger the company (that is, the larger the market cap), the higher the market value but also the lower the growth potential.
If you seek lower risk: Look for large-cap companies with a history of producing quality goods and/or services as well as consistent dividend payments. Further, you should look for companies with a history of steady dividend growth.
If you are comfortable with medium risk: consider mid-cap stocks. The stocks of these companies may have more growth potential. They are typically working to increase market share in industries that may be experiencing rapid growth. While they may be more risky than large-caps, in my experience they offer less market risk than small caps.
Higher risk: Those small-caps, which are generally younger companies that serve emerging markets and niche markets, could have a market value as low as $300 million. Typical risks can include their increased susceptibility to economic or business downturns as well as competitive risk from similar companies.
Not for the risk-averse: Micro-caps are typically more volatile and need thorough research before investing in them. In addition, the potential for growth can be relatively small.
Note that market cap can be affected by changes in the value of the shares, but not by stock splits.
Why not simply compare by stock price?
In my opinion, just looking at stock price doesn’t give you an accurate picture for comparison. Many people think that the higher the stock price, the larger the company. But the stock price can misrepresent a company’s actual worth. Among other factors, the true value of the companies is affected by the number of outstanding shares they have.
While having a portfolio that contains a variety of market caps isn’t the only way to diversify your portfolio, it is one way to reduce investment risk and help you achieve your long-term financial goals.
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Provided by courtesy of Herb White, MBA, CFP®, a CERTIFIED FINANCIAL PLANNER™ with Life Certain Wealth Strategies, 8400 E Prentice Ave, #715 Greenwood Village, Colorado, www.lifecertain.com, (303) 793-3999. Securities and investment advisory services offered through Woodbury Financial Services, Inc. Member FINRA, SIPC and Registered Investment Advisor. Life Certain Wealth Strategies and Woodbury Financial Services are not affiliated entities.