In the world of personal finance, it seems that everything has a name, and some terms are even further shortened to acronyms and nicknames. The tendency to save time with abbreviations makes investing concepts opaque that should be simple to understand.
At DreamWork Financial Group, we want all investors to feel confident when reading financial media and discussing their investment decisions. That’s why we explain common jargon to clarify investing concepts and make the markets more accessible.
One of the most important concepts in stock investing is market capitalization – frequently shortened to “market cap.” This is often the first criteria used to separate stocks into categories that represent parts of a diversified portfolio, so be sure to understand the definition.
What is Market Capitalization?
Market capitalization is a measure of the size of a publicly traded company. It is a unique yardstick because it gauges the total value of the stock, rather than components like revenue or profitability.
You would calculate market capitalization manually by multiplying the current stock price by the number of shares outstanding. However, this arithmetic is generally not necessary, since market cap is listed on most stock quotes.
Like other measurements of a company’s value, market capitalization is used to compare one stock to another. It is also used to categorize stocks based on company size, so you can follow specific segments of the market and determine which companies to include in your portfolio.
The Three Main Categories of Market Capitalization
A stock generally falls into one of three market cap “buckets” – large-cap, mid-cap, or small-cap. Companies inside each of these buckets can vary dramatically, but the general classifications help to assess the potential risk and reward of an investment.
Large-Cap Stocks: Titans of Industry
There are no definitive rules about the size of companies that are considered “large-cap” or “small-cap,” but investors have unofficially settled on some common breakpoints. Stocks above the unofficial $10 billion threshold are generally considered large-cap.
Large-cap companies are often household names, like the Magnificent 7 – a group of stocks including Apple, Amazon, and Google. These companies dominate two of the most commonly followed stock indices, the Dow Jones Industrial Average and S&P 500.
Since large-cap companies are generally much more powerful than smaller counterparts, they tend to have more stability during times of economic stress. These companies often have several product lines and methods for generating revenue, as well as robust cash reserves. The combination allows many of them to survive trying times that are more likely to bankrupt smaller firms.
On the other hand, the sheer size of large-cap companies means they generally have less room to grow than smaller businesses. Because of this dynamic, their stock prices also tend to grow less quickly during periods of expansion.
Mid-Cap Stocks: Rising Stars
Stocks with a market cap between $2 billion and $10 billion are often considered “mid-cap.” These companies have generally expanded past the startup phase and have a proven business model, but they haven’t reached the threshold to become a household name.
Mid-cap companies are often in a period of rapid growth, stretching their wings and seeking to become large-cap companies in the future. They may have several product lines and avenues for growth but are often less diverse than larger firms.
Due to the proven capabilities of these companies, they can be more comfortable in challenging markets than smaller firms, but less comfortable than large-cap companies. Their stock price tends to be more volatile than large-cap stocks, but less volatile than small-cap companies.
Small-Cap Stocks: The Growth Engines
Small-cap companies are those with a market value under $2 billion. These are nimble firms that are just starting or serving a specific niche. They are often younger than mid- or large-cap companies and generally carry more risk than their larger firm counterparts.
These smaller companies often have significant growth potential, and a successful product launch or expansion can have an outsized impact on their business and their stock price. On the other hand, failure in one area can also quickly erode market value.
The smaller nature of these companies means that economic downturns can hit them harder than larger companies, as small-cap stocks generally lack the diversification and cash reserves of their larger counterparts. However, this increased risk also means that sound small-cap stocks tend to outperform during periods of expansion.
Diversifying Based on Market Capitalization
Diversification is the process of investing in multiple investments that have a low correlation to reduce overall risk. One way to diversify your portfolio is to invest in multiple stocks with different market caps.
A base of large-cap stocks with exposure to mid- and small-cap companies is a proven strategy to reduce risk during market downturns while capturing growth potential during periods of expansion. However, your portfolio should be created with your individual risk tolerance in mind.
An experienced financial advisor can help you weigh the risk and potential benefits of investing in stocks, as well as determine the optimal mix of assets to help you achieve your goals. As you search for the right advisor, be sure to seek a professional who specializes in stocks, as they have experience crafting a portfolio of individual securities.
Get A Custom Stock Portfolio from DreamWork Financial Group
At DreamWork Financial Group, we strive to help all investors achieve their financial goals through personalized investing. Our innovative wealth management program, Investing Gameplan™, includes a tailored portfolio of individual stocks and low-cost ETFs that is created just for you.
When you invest with us, your advisor is your portfolio manager, so you can ask detailed questions about your investments and get honest, well-informed answers. If you think this level of personalization is just for the very wealthy, think again. Here at DreamWork Financial Group, You Don’t Have to Be Wealthy to Have Wealth Management®.
To get started with your custom portfolio, contact a member of our team today.