Market capitalization, or market cap, measures a company’s worth by looking at the total value of its outstanding shares.

🤔 Understanding market cap

Companies are typically divided into three categories: small-cap, mid-cap and large cap. Investors often use market cap to evaluate an investment’s potential risks and benefits.

How to calculate market cap

Market cap provides a quick, easy estimate of what the market says a company is worth. It’s calculated by multiplying a company’s share price by the number of shares in circulation. For example, a company with one million shares worth $100 each would have a market cap of $100 million.

A company's share price depends on factors like supply, demand and investor sentiment. In turn, this affects market cap, as its value fluctuates with changing stock prices.

Note that market cap can also change due to a company issuing new shares or an investor exercising their warrants. That said, market cap is usually not affected by stock splits or dividends, as share price usually drops to compensate.

What this means for you

Knowing a company’s market cap can give you an idea of its value and potential risks and benefits. Additionally, investing amongst varying market caps is an easy way to diversify your portfolio and mitigate risk.

Generally, you can divide companies into three basic categories:

• Large-cap stocks have a market value of $10 billion or more. They often boast stable business models and a history of steady growth and dividend payments. As they’re less prone to explosive growth than smaller stocks, you may not see huge, short-term returns, but they’re typically more stable and less risky.

• Mid-cap stocks have a market value between $2 billion and $10 billion. Typically, these are well-established companies that still have room for growth in their revenues, market share, and competitiveness. Investing in mid-caps is riskier than investing in large-caps, but you may see greater growth and increased dividends.

• Small-cap stocks have a market value between $300 million and $2 billion. These tend to be young companies in niche or emerging industries. Generally, they’re some of the riskiest investments due to their age, size, lack of liquidity, and sensitivity to economic slowdowns. But they’re also considered more aggressive, as they have greater growth potential.

You can also invest in micro-caps, valued between $50 million and $300 million, or mega-caps valued over $200 billion. Unsurprisingly, micro-caps tend to be riskier with greater growth potential. Mega-caps are lumbering behemoths of the investment world: they don’t move quickly, but they can offer stability and decreased risk.

Overall, understanding market capitalization makes it easy to:

• Compare the relative size of companies
• Measure how the market values an investment
• Identify diversification and risk potential in your portfolio
• Generalize the relationship between company size, risk and return

And, on the whole, considering market capitalization can help you spread your risk while maximizing returns according to your risk tolerance.