Cap, short for "capitalization," refers to the price of a stock multiplied by the total number of shares outstanding. The higher this number is, the greater the capitalization of the stock. The term always refers to size, and stocks are grouped accordingly, ranging from “large cap” on the high side, down to “micro cap” on the low side.
Why Cap Is Important
Investments are divided by asset class, such as stocks and bonds. Stocks are further divided into large cap and small cap (and sometimes mid cap) classes. Nobel laureate Harry Markowitz discovered that you can balance your investment returns against your potential risk by apportioning your money among different asset classes. Because asset classes tend to perform differently, one asset class might perform well when another is falling.
Large cap stocks tend to be household names, such as Proctor & Gamble or ChevronTexaco. These companies are traditionally steady, paying reliable quarterly dividends and reporting predictable earnings. A stock usually falls into the large cap category if its capitalization is $10 billion or more. Companies in the small and micro cap range are not as well known. They strive for growth, and their volatile performance makes them more risky. Technology firms are often found in this category; one is Insight Enterprises Inc., with a capitalization well under $1 billion.
Plug any ticker symbol into your favorite quoting site, and you will see market cap listed as one of the key pieces of information. Finding stocks in a particular capitalization range is a little trickier, and you may want to rely on your brokerage firm’s site for stock screening tools. Alternatively, typing the key words “best small cap stocks” into your favorite search engine will yield lots of information.
The more highly capitalized the stock, the greater effect its movement will have on the overall stock market. The 30 components of the Dow Jones Industrial Average are all highly capitalized; a large drop in just one of these stocks can drag down the entire market. All it takes is an oil spill or a revelation of accounting manipulation to affect the prices of thousands of other stocks.
Knowing the capitalization of a stock provides important clues about what to expect from it. If you are willing to take a gamble on a quick win, you’ll want to look at small cap stocks--the smaller the better. If you're looking for steady dividends and lots of information and analysis, look for large cap stocks as a starting point. Past performance is no predictor of future returns; you can lose money investing in stocks.
- The Journal of Finance Volume III: “Portfolio Selection”
- Schwab: “The Portfolio Pyramid: How to Diversify Your Investing”
- Schwab: “Constructing a Diversified Stock Portfolio”
- “Market Watch: U.S. Stocks Slip; Energy Shares Down As BP Oil Spill Continues”
- Fidelity. "Understanding Market Capitalization." Accessed Oct. 26, 2020.
- National Bureau of Economic Research. "NBER Working Papers Series: Asset Pricing With Liquidity Risk," Page 4. Accessed Oct. 26, 2020.
Julia Thomson began writing professionally in 1996. Her work has appeared in "Stage Directions," "Phoenix New Times" and "The Valley Callboard." Thomson has expertise in investing and personal finance, with three brokers' licenses and certification as a budget counselor. She holds a Master of Music from Indiana University.