What Does Market Cap Really Tell Us?

The next time you're standing in line at your favourite coffee shop, among the caffeinated temptations you'll also have to decide how to size your beverage order. Depending where you are, that could mean small, medium, large, or maybe short, tall, grande or venti. But how do they all compare to one another? Like coffee, companies come in a variety of sizes and are classified as "market capitalizations" or "market caps," such as small-, mid- and large cap. Companies with similar market caps share attributes such as expected volatility, liquidity, return potential and risk.

What is market capitalization?

Market capitalization is the total value of a company's shares. The simple calculation is: Total number of outstanding shares multiplied by the current share price. So, if Company A has 10 million shares outstanding and the current price of one share is $10, Company A's market cap is $100 million.

Why is market capitalization important for investors?

A balanced portfolio typically includes a mix of different market caps because each has unique attributes that contribute to an investor's long-term goals. Market cap allows investors to measure a company's size.

Large caps generally have a market value of over $10 billion, tend to be mature companies that pay regular dividends, are perceived as more conservative investments and often form the core of many portfolios. At the other end of the spectrum are the small caps, which tend to have market values around $250 million or $300 million to $2 billion. These are typically younger businesses that are growing rapidly and are perhaps reinvesting their cash flow into the business rather than paying it out in dividends. Mid caps, typically with valuations between $2 billion and $10 billion, may still be growing or may be planning to remain in mid-cap territory. Because of their size, they can be less volatile than small caps and may be lower risk than their smaller counterparts.

What affects a company's market capitalization?

Based on the equation above, there are only two levers for changing market cap: share price and shares outstanding. For example, if the price increases, then all things being equal, the market cap will increase, too.

However, stock splits and stock dividends wouldn't affect a company's market cap. For example, in a 2-for-1 stock split, the investor receives one additional share for each share owned. The number of outstanding shares doubles but the stock price is halved, meaning the market cap wouldn't change. If a company decides to issue a dividend in the form of company shares instead of cash, this increases the float but the dilution would weigh on the share price.

Market cap is just one metric to consider when making investment decisions and determining the right balance in a portfolio for you. That balance may include a diversified mix of not only assets, industry sectors and geographies, but also of market caps.