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What in the world is a market cap?

Market capitalization, also known as "market cap," refers to what a company is worth on the open market. Put another way, it's what it would take to buy all a company's shares at the current price.

Market cap is determined by multiplying the number of shares outstanding by the current price per share. Suppose Company ABC's stock is trading at $20 and there are 10 million outstanding shares. Multiply the two numbers and you learn that ABC has a market cap of $200 million.

Why should you care about a company's market cap? For one thing, different cap sizes tend to perform differently. Large-cap companies led the recent bull market, for example, while small companies lagged behind. But over time, smaller companies have returned about 2 percent more than large companies (12.6 percent a year vs. 10.7 percent).

Additionally, many institutional investors -- mutual funds, insurance companies, etc. -- aren't interested unless a company's cap is above $100 million. Then there are some mutual funds that specialize in companies with teeny market caps.

The financial masters of the universe have conveniently divided the stock playing field into four main cap categories, though the categories tend to overlap.

Large cap ($5 billion or more): These are the blue chip companies -- General Electric, Coca-Cola and Disney. These companies frequently are involved in several industries at once. GE, for example, is a media company, a financial services company, and a manufacturer. Large caps usually pay dividends and are also the most "liquid," meaning that there are always plenty of buyers and sellers for shares of these companies.

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Midcap ($750 million to $5 billion): Midcaps rub shoulders with the blue chips, but aren't quite as giant and are typically focused on fewer businesses. They long to achieve blue-chip status, but often are in a make-or-break phase of operation. Companies that don't make the leap to large capitalization during their big growth phase often never do.

Small cap ($150 million to $750 million): These companies aren't as well established as their larger counterparts, but they're often growing faster. Remember, most of today's great blue chips were tiny small caps once. When investors talk about finding "the next Microsoft," they mean buying a company when it's small and cheap and riding its stock to dizzying heights. Buying these stocks is like keeping in touch with your mad scientist cousin because he might just invent the next great widget. Then again, he could blow himself up in the process, so you need to keep a close eye on him.

Microcap (Below $150 million): Microcaps are by far the riskiest, since they usually have small cash reserves and only one or two products to lead performance. Additionally, since microcaps have a small number of shares out there (known as a small "float"), these shares have low liquidity. This can sometimes makes them difficult to sell, especially when the company is in some sort of trouble and investors are all trying to sell at once. Many microcaps are companies you've never heard of.

Experts normally advise keeping a nice mix of stocks in your portfolio. So what's a nice mix? Well, that depends on your goals, assets, risk tolerance and how soon you are likely to meet your maker. Young, aggressive investors often invest in more volatile small caps — either the companies themselves, or mutual funds that specialize in small caps — while older investors usually focus on conservative large cap funds.

Keep in mind that market cap figures can border on the insane, especially in volatile markets. When Priceline.com hit its high ($165/share) before the tech wreck in early 2000, it had a market cap of about $23 billion -- more than United, American and Delta combined. Not bad for a company that lost about 40 cents a share on estimated 1999 revenues of $141 million (compared to, say, American, which earned about $1.3 billion that same year on revenues of $19 billion). This tells you that investors sometimes care a lot more about a company's growth potential than about its current operations. The market clearly felt that Priceline would grow a lot more quickly than these airlines — but it's worth noting that Priceline dropped like a rock when the market took a tumble.

You may also hear capitalization discussed as the sum of a corporation's long-term debt, plus stock and retained earnings. This type of measure is based on the idea that if someone were to buy the company then they'd have to assume any existing debt, which in turn raises the price they wind up paying.

Let the analysts worry about calculating all that stuff. The main thing you need to know about cap size is that bigger isn't always better and diversity of sizes often produces the most stable portfolio.

-- Posted: Nov. 10, 1999

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