Market capitalization (or market cap) refers to the total value of a publicly-traded company’s shares that allows investors to evaluate how much a company is worth.

To determine a company’s market cap, you would multiply the total number of outstanding shares by the current market price of one share. For example, shares of Costco Wholesale are selling for $302.45, with 441.52 million shares outstanding.  Thus, $302.45 multiplied by 441.52 million equates to a market cap of $133.54 billion.

So, essentially there are two elements that make up a company’s market capitalization:  outstanding shares and share price.

However, if you really were to buy a company outright, it would be a bit more complicated and require the inclusion of the total debt, cash, and cash equivalents, as well as its market cap, to determine the overall value.

Market capitalization is important because it reflects what investors are willing to pay for its stock.

Typically, companies are grouped into categories based on their market caps:

Large-cap:  Generally, companies with market caps over $10 billion are considered large-cap and include household names like Coca-Cola, Apple, and Johnson & Johnson.

While many companies deal with the ups and downs of their industry’s cycle, these are often the strongest and have proven capable of holding off competitive threats.

Mid-cap:  Mid-cap companies are established companies that operate in an industry expected to experience rapid growth and generally have a market capitalization of between $2 billion and $10 billion.

Often these companies have made considerable progress in building successful business models, giving investors some stability and protection against future failures.

Small-Cap:  Companies with a market capitalization between $300 million to $2 billion are classified as small-cap companies and tend to be younger or serve niche markets.

Small-cap stocks are generally more volatile than larger caps and are best owned as a diversified group and, for many years, to reduce risk.

Why is market cap important

Market cap is important for a number of reasons.  First, a company’s market cap is established through its initial public offering.

Before an IPO, the company that wants to go public seeks assistance from an investment bank to employ valuation techniques to derive its value and determine how many shares it will offer to the public and at what price.

The larger the company’s market cap, the higher its stock’s trading volume is likely to be. Moreover, stocks with a large market cap are easy to buy and sell because of their trading popularity between investors and institutions.

It also has a relationship with a stock’s stability, but while market cap is just one aspect to consider when trying to achieve a diversified portion, having a variety of companies with different market caps can help spread risk.

The final word

For investors who wish to pursue long-term financial goals, creating an investment strategy and understanding the relationship between a company’s size, the risk, and return potential is critical.

With a solid knowledge of financial terms, investors will be better prepared to build a balanced portfolio that includes a mixed bag of “market cap” stocks.