Share:
Company Size -- Why Market Capitalization Matters
Rate this article: Thank you for rating this article.

Stocks represent ownership in companies of various sizes. Understanding the relationship between company size, return potential, and risk is crucial if you're creating an investment strategy. With this knowledge, you'll be better prepared to build a balanced stock portfolio that comprises a mix of market caps.

Sizing Up Stocks

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.

Market cap definitions can vary, so the following are general guidelines.

  • Large-cap: Market value of $10 billion or more; generally mature, well-known companies within established industries.
  • Midcap: Market value between $3 billion and $10 billion; typically established companies within industries experiencing or expected to experience rapid growth.
  • Small-cap: Market value of $3 billion or less; tend to be young companies that serve niche markets or emerging industries.

To calculate a company's market capitalization, multiply its stock's current price by the total number of outstanding shares. For example, if a company issues one million shares of stock trading at $50 each, its market capitalization is $50 million ($50 times 1,000,000 shares).

Evaluating Risk and Reward Potential

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. In turn, midcap stocks generally fall between large caps and small caps on the risk/return spectrum.

Why? 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. Therefore, midcaps may offer more growth potential than large caps.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.2

A standard method of gauging the performance of an investment is to measure its returns against those of an index representing similar investments. As with stocks, indexes come in all sizes and shapes. The Standard S&P Poor’s (SS&PP) 500 is the best-known yardstick for large-cap stocks. As their names suggest, the SS&PP MidCap 400 and SS&PP SmallCap 600 indexes represent midcap and small-cap stocks, respectively. The Russell 2000 is another prominent index for small-cap stocks.3

Selecting the Right Combination

So what does a company's size have to do with your investment strategy? Quite a bit. Over time, large-cap, midcap, and small-cap stocks took turns leading the market as each can be affected differently by market or economic developments. That's why many investors diversify, maintaining a mix of market caps in their portfolios. When large caps are declining in value, small caps and midcaps may be on the way up and could potentially help compensate for any losses.

To build a portfolio with a proper mix of small-cap, midcap, and large-cap stocks, you'll need to evaluate your financial goals, risk tolerance, and time horizon. A diversified portfolio that contains a variety of market caps may help reduce investment risk in any one area and support the pursuit of your long-term financial goals. Keep in mind, diversification does not eliminate risk or the risk of potential loss.

Rate this article: Thank you for rating this article.

1Stocks of midcap companies pose special risks, including possible illiquidity and greater price volatility than stocks of larger, more established companies.

2Stocks of small-cap companies pose special risks, including possible illiquidity and greater price volatility than stocks of larger, more established companies.

3 The S&P 500, S&P MidCap 400, S&P SmallCap 600, and the Russell 2000 are unmanaged. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.

© 2015 Wealth Management Systems Inc. All rights reserved.

This material is authored by Wealth Management Systems Inc. and was not authored by Merrill Edge. Assumptions, opinions and estimates constitute judgment from Wealth Management Systems Inc. as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

Banking products are provided by Bank of America, N.A. and affiliated banks. Members FDIC and wholly owned subsidiaries of Bank of America Corporation.

ARC9DX6N