What is market capitalization?

Market capitalization, or market cap, is the total value of a company's stock within the stock market. Calculating a publicly traded company's market cap is easy: Just take the number of shares of stock the company has issued and multiply it by the current market price of the stock. So if a company has issued a total of 2 million outstanding shares and each share is valued at $20, then the company's total market capitalization is $40 million.

But why is market cap important, and how should you use it? Market cap is one of the best measures of a company's size, and size can tell you a lot about what to expect if you buy its stock.

  • In general, large companies tend to have more stable and mature businesses, having proven themselves over time and weathered difficult business conditions to emerge stronger. However, the growth prospects for large companies tend to be more limited, because they've already taken advantage of their primary opportunities to grow to their current size.
  • By contrast, smaller companies have a lot more room to grow. However, smaller companies tend to be younger, with riskier business models that haven't yet proved themselves over time. Their odds of failure are significantly higher than those of larger companies.

Here's a quick breakdown of the way market capitalization ranges are often segmented and discussed within the stock market:

Type of Stock

Market Capitalization Range

Mega-cap

More than $200 billion

Large-cap

$10 billion to $200 billion

Mid-cap

$2 billion to $10 billion

Small-cap

$300 million to $2 billion

Micro-cap

$50 million to $300 million

What are large-cap stocks?

Large-cap stocks have market capitalizations of $10 billion or more. Most of the best-known companies in the world are large caps, and some investors break out stocks with market caps of more than $200 billion into a separate category as mega-cap stocks.

Most large-cap companies have mature business models and generate substantial amounts of revenue. They often earn significant profits and have considerable market share within their industries, making them leaders in their fields. They're more likely than smaller companies to pay sizable dividends to their shareholders, because their businesses tend to produce greater amounts of available cash.

On the other hand, large-cap companies have often already gone through their period of maximum growth. As a result, even successful large-cap companies that pay healthy dividends and whose shares go up in value consistently won't always be able to match the massive returns that smaller companies can achieve.

Read more: Large-Cap Stocks

What are mid-cap stocks?

Mid-cap stocks have market caps in the range of $2 billion to $10 billion, occupying the middle ground between large and small companies. Mid-cap companies are large enough to have made considerable progress in building up successful business models, and that gives their investors some stability and protection against future challenges those companies will face. However, they're small enough that they give investors a longer runway for future growth than a large-cap stock. That said, mid caps also face the difficult task of catching up to and surpassing larger rivals in their industries, and they don't have as many financial resources at their disposal.

It's important when investing in mid-cap stocks to know their history. Some mid-cap companies are still in their high-growth phase, while others have reached their full potential in relatively small niche industries of limited size. Still others are older companies that used to be large caps but have seen their businesses lose steam. Any of these can be good investments under the right circumstances, but they can have very different characteristics in terms of growth potential, dividend income, and valuation.

What are small-cap stocks?

Small-cap stocks have market capitalizations of between $300 million and $2 billion. Some people also include within this category even smaller companies with market capitalizations of $50 million to $300 million, while others put those tiny stocks into a separate group as micro-cap stocks. Small-cap companies tend to be younger than large caps or mid caps, and they often have a much shorter track record as operating businesses. Small caps often have considerable growth potential, but investors in small caps face a lot more uncertainty about their future. In many cases, small caps have to upend much larger competitors in order to stake their claims within a given industry, and for every small company that succeeds, many fail.

Over time, small-cap stocks have historically produced higher average returns than large-cap stocks, but their performance has been more volatile along the way. That requires small-cap investors to have a greater risk tolerance than those who concentrate on larger stocks. Those with long time horizons can typically weather the ups and downs of small-cap stocks and therefore have a better chance of enjoying the reward of greater returns.

Read More: Small-Cap Stocks

How to use market cap

Most investors find that having a diversified portfolio that includes large-cap, mid-cap, and small-cap stocks lets them tailor their desired return and risk levels to their specific wishes. If you want your portfolio to be more stable, then you'll want a larger allocation to large-cap stocks. Those who want greater amounts of current income will also typically gravitate to large caps. By contrast, if you don't need much income and your primary goal is to have your portfolio grow as much as it can over many years, then you'll likely want to make larger investment allocations to small-cap and mid-cap stocks.