When you are considering investments, you may hear the terms “small cap,” “mid cap,” and “large cap” with regularity.  It is important to understand the intricacies of these terms, as they can significantly impact your risk to reward ratio.

Market cap fundamentals

“Cap” is an abbreviation for capitalization, which is a measurement of a company’s size.  This measurement is not a fixed number, but instead helps you gauge the size of a company and how much risk it carries.
The concept of market capitalization is straightforward.  It refers to the value of a company’s shares that are available.  The number is determined by taking the price of the stock and multiplying it by the total shares that are outstanding.

Market cap measurements clear up misconceptions.  Some new investors believe that the more expensive a stock is, the bigger the company must be.  However, this is a false impression, since the number of shares of stock is not constant from one company to another.

What market caps mean to your portfolio

By classifying companies into different caps, you can more accurately gauge the growth-to-risk ratio.  Generally, the larger caps grow more slowly, but carry less risk.  Smaller caps tend to grow faster, but also pose a higher risk.

While there is no established formula of defining specific market caps, there are some general standards.  These numbers can fluctuate depending on how the market is doing as a whole.

• A “mega cap” is a company that has a market cap of $200 billion or more.  They are the companies that are traded the most, including big names like Microsoft, Exxon, and Wal-Mart. 

• A “big/large cap” is a company that has a market cap from $10 billion to $200 billion.  Some of these companies would include Yahoo, IBM, and Citigroup.  Large and mega caps are both pretty stable, often being referred to as “blue chips.” 

• A “mid cap” is a company that has a market cap from $2 billion to $10 billion.  Many of the companies in this category are growth stocks, and on a whole, mid cap companies are considered more unstable than the bigger players; however, some of these mid cap stocks can grow to become into industry leaders. 

• A “small cap” is a company that has a market cap between $300 million and $2 billion.  Usually comprised of new or young companies, small tremendous potential to earn money, but also poses a considerable amount of risk. 

• A “micro cap” is a company that has a market cap from $50 million to $300 million.  Penny stocks make up the majority of this category, and it often can be a coin toss as to whether these companies will prosper or fail.  These stocks require in depth research, as well as a high tolerance of risk, before investing. 

• A “nano cap” is a company that has a market cap of under $50 million.  The most risky of investments, the potential of gains on these stocks is relatively small. 

Having an understanding of market cap is not only important for stocks, but also for mutual funds investments.  Many mutual funds will list the middle ground for their investments, allowing you to understand the type of stocks the funds primarily purchase.