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Market Capitalization – Company Size Investing

Dividing the universe of stocks by market capitalization or company size is an approach that investors and writers have used over the years. There is no standard cut off classification distinguishing between large and small companies. Currently, most investors use market capitalization rankings to define size, rather than sales and profit rankings. I will therefore be discussing market capitalization in this section.

Market capitalization represents the amount of shares the company has outstanding, multiplied by its share price. This ranking system measures the market value of companies, not their sales and profits. In many instances, there is no correlation between market value and profits.

The broad categories of market capitalization are Large Cap, Mid Cap and Small Cap. Additionally, in each category there are value and growth stocks and companies in-between. Generally, large companies are more stable than small companies. The gradual switch from sales and profit rankings towards market capitalization rankings, was also a shift away from the fundamentals towards more speculative investments. Discussed below are the categories:

            Large Cap. – The global business institutions of the world; Fortune 500 or Forbes 500 type companies. They also include many of the popular growth companies that have promising prospects. These organizations dominate their markets. The large cap companies normally grow with the economy and enhance their stature through acquisitions. They usually derive a substantial part of their business from international operations, which may mitigate the risk of a devaluing U.S. dollar.  Market capitalization for such companies is typically in the $10 billion plus range.

            Mid Cap. – The Russell 2000 type companies, or many of the companies found in Value Line that are not in the Fortune few hundred. Many of the companies are household names, have excellent brands and products, and usually can grow faster than the general economy. They have already made the switch from a smaller company environment to a professionally managed organization. Many are international in scope and financially strong, with professional management, corporate governance procedures and internal audit departments. Mid cap companies have established strategic planning, marketing, finance, accounting, production, human resources and information technology departments. These stocks are traded on the major exchanges; they normally grow faster than the large cap stocks, but they also carry more risk. Capitalization ranges from $2 billion to $10 billion.    

Small Cap. – Capitalization is less than $2 billion, and may also include larger companies that ran into financial difficulties. They usually have a niche product, don’t have deep pools of management talent, and don’t pay dividends. Many have no research analyst following them, and are ignored by the large funds. Many would be unable to survive a market or business downturn. On the positive side, there are many reasonably priced, quality growth and value small cap stocks, which you can make money on.  Because of the extra risk, you can normally find reasonably priced small cap companies at a P/E discount in comparison with their large cap peers. Historically, small cap companies in the aggregate have      out-performed the large cap companies. The “January effect” is also worth noting; small cap companies that decline at year-end due to tax selling, often slightly rebound in January.

In summary, the capitalization dollar ranges are subjective and fluctuate with the market. Depending upon how you slice the universe of stocks and the time periods you use, performance statistics will be different. Once again, while larger companies are normally financially stronger, better-managed, and less risky than smaller ones, each needs to be evaluated individually.

Regarding investing ideas for young adults, normally young investors view the secure, slow growth, large cap companies as their fathers’ stocks, which they shy away from. These companies take time to acquire a taste for. Often, however, youth gravitates, to their detriment, towards the risky, unproven, start-ups and small cap companies. There is, however, a solution to the generation gap. Focus on the mid cap stocks. These are typically not your father’s or grandfather’s stocks, yet they are usually somewhat secure and can offer exciting returns.  

 

 

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