Why Is Market Cap Important?

Market capitalization, or market cap, is one of the more important features of a company's portfolio. Investing in companies with a small- or mid-cap stocks will result in an investment portfolio with greater risk factor. However, a high-risk portfolio may generate higher returns over time than stable, consistent stocks. Nevertheless, inexperienced investors should probably stick with lower-risk stocks with a high market cap.

Market cap is the sum total of a company's outstanding shares. The calculation is used to determine the value of a company. For example, if a company has 20 million shares outstanding, at a value of $100 per share, the market cap for that company is $2 billion. Outstanding shares represent the amount of ownership in the company, which is why market cap is commonly used to determine the value of a given company.

There are several levels of market cap. Although specific ranges may vary, generally speaking, a company with a market cap that is less than $2 billion is considered a small cap. Mid-cap companies are those with a market cap between $2 billion and $10 billion. A large-cap company has a market cap over $10 million. Mega-cap companies have market cap that exceeds $200 billion, and include major companies such as Walmart and ExxonMobil.

As noted in the book "The Stock Investor's Pocket Calculator," some investments use market cap as a tool to diversify their investment portfolios. A properly diversified portfolio minimizes risk by providing protection in unstable stock market conditions. If diversification is your goal, invest in companies that have a range of market capitalization rates. Other ways to diversify your portfolio include investing in international companies and choosing funds with different specialties, such as real estate or technology.

Market cap indicates other features about a company. Market cap is a much more accurate measure of a company's value than other figures such as market value per share, because it accounts not only for the value of shares, but also for the amount of investors who are actually willing to invest in them. However, that doesn't mean that you should only invest in companies with a high market cap. Low- and mid-cap companies are more unpredictable and volatile, but they may generate higher returns if you play your cards right.