Market cap is a key guidepost for anyone building a portfolio. Here's what to know.
Ever get a headline or an alert about a particular company’s stock that has lost or gained a significant percentage of its value in a day?
That’s a direct reference to the company’s market capitalization—market cap for short.
And it’s not just for headline writers. Professional portfolio managers and financial research firms with familiar names like S&P Global and Dow Jones® rely on market cap to frame their analysis of companies old and new within specific industries.
Market cap represents the real-time value of any publicly traded firm based on shares of stock you could buy right now on the open market. Here’s the market capitalization formula:
Market capitalization = Total shares outstanding x Stock price
Now, let’s go a little deeper.
A company’s outstanding shares are a key element in fundamental analysis, illustrating the broadest number of a company’s shares subject to daily valuation. That’s why market cap is a good barometer to use to determine how a firm ranks against other competitors at any moment. However, it’s also good to know the power dynamics within outstanding ownership numbers, which we’ll get to below.
The thinkorswim® platform provides a deep dive into company fundamentals. As shown in figure 1, you can easily find any stock’s real-time market cap in five steps:
Step 1: Log in to thinkorswim and select the Analyze tab.
Step 2: Enter a stock symbol.
Step 3: Select Fundamentals.
Step 4: Select By the Numbers and choose whether you want to see data on an annual or quarterly basis.
Step 5: Scroll to the bottom of the screen to view the stock’s Total Shares Outstanding and Market Cap.
Any investor—professional or individual—can use market cap to group stock choices along a particular industry category or investment theme.
“Big moves in market cap get attention, but if you’re investing in companies, market cap is just a starting point for what you’ll need to know,” said Viraj Desai, director, Charles Schwab Investment Management. “For example, larger-cap companies generally have a track record of long-term success and stability, so you’d want to watch how companies within that size range are performing as a group and why.”
As for smaller-cap firms, risk comes into play, Desai noted. “Small-cap or micro-cap stocks are generally younger firms with relatively short track records that require deeper due diligence to determine their prospects,” Desai added. “Market cap provides a shorthand for the way you’ll evaluate companies—or groups of companies—as they grow and mature.”
The Financial Industry Regulatory Authority (FINRA), the U.S. financial industry’s self-regulatory body overseeing investment broker-dealers, categorizes market cap as follows:
“Both professional and individual investors can build
their portfolios with market capitalization as a consideration for the goals
they want to reach,” Desai said. “Market cap can introduce you to
choices that fit your risk appetite, investing time horizon, and market
Within the mutual fund, exchange-traded fund (ETF), or
investment management world, market cap can often reveal other insights. “If
you see a particular manager with a few small-cap holdings in what’s supposed to
be a large-cap fund, that’s what’s called ‘style drift,’ and it is frequently
used to generate excess returns,” he explained. “The problem is that too
much style drift can violate the fund’s objective.”
That’s why market cap should just be “a starting point”
for your stock analysis—the first stage of a filter that narrows down your
universe of asset selection, according to Desai.
Most of the major
stock indexes, such as the S&P 500® index (SPX) or Nasdaq-100® (NDX), are market-cap-weighted, meaning stocks
are selected and tracked based on their real-time market caps. To be included
in such an index, a company needs to maintain a market cap that exceeds the
index’s minimum value. For example, the minimum market cap for inclusion in the
SPX is currently $14.6 billion, according to S&P Global.
If a company’s share price falls and its market cap is below
the index’s minimum, the company usually has 30 days to raise its market cap
above the minimum or face potential elimination from the index. Such index
additions and subtractions are common and require a replacement stock and a
rebalancing of the overall index based on the new addition.
However, market-cap-weighted indexes are not the only game
One drawback of market-cap-weighted indexes is that they can
be prone to concentration risk, which means that an index may be overweight
based on the performance of a small number of companies within the group. For
example, the top 10 holdings of the SPX accounted for more than 30% of the
total index as of the end of October 2023.
Some investors prefer to check
what are known as equal-weight indexes, where each stock in a major index is
weighted by an equal percentage, decreasing the risk of a small handful of
stocks dominating an index’s performance. For example, in the S&P 500 Equal
Weight Index (SPXEW) each stock accounts for 0.2% of the total index. Given the
high concentration in the market-cap-weighted SPX, an allocation to an equal-weighted
index can diminish the risk of overconcentration, while allowing you to still
access the pool of companies that make up the SPX.
In early September 2023, Apple’s (AAPL) stock price lost
nearly 10% over two days after the Chinese government decided to strengthen its
ban on state employees using Apple products. Given the size of the Chinese
market and the popularity of Apple’s products in China, the announcement dealt
a serious blow to the company’s valuation. While stocks can recover, sudden
moves in market cap can be a worthwhile trigger that it’s time to do more
research on a company’s future prospects (see figure 2).
Learning new investment tools is important, but all have their limitations. Here are a few to consider as you use market cap to invest:
Market cap is a
solid first indicator to help you evaluate a potential investment’s market
value. You can use it to measure investments against your risk tolerance and
growth targets as you build a portfolio over time. However, it’s important to
dig a bit deeper to get the full picture of a stock’s or fund’s individual
performance. You’ll find thinkorswim provides hundreds of studies and data points to help you do just that.
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