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-- Posted: Jan. 26, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

Market cap

Dear Dollar Diva,
What is market capitalization?


Market capitalization is the value of all shares of a company's stock outstanding (that is, in the hands of the public) at the current share price. If a company has 1 million shares outstanding, and the stock is selling for $100 a share, the company's market capitalization would be $100 million. Market cap is used as a guide for diversification. Companies are classified by market cap. Classifications are not set in stone, but this will give you an idea of how they work:

Classification Market capitalization
Large-cap: More than $5 billion
Mid-cap: $1 billion to $5 billion
Small-cap: $200 million to $1 billion
Micro-cap: Less than $200 million

Who values the shares?

Why does a stock go up from $50 a share to $60 a share? And what makes it go down? Theoretically, the market -- the investors who buy and sell the shares -- determines what a stock is worth. Investor expectations in three areas are the driving force behind the movement in a stock price:

  • Earnings growth
  • Inflation
  • Risk

Why are tech stocks so highly valued?

Investors have placed a high value on tech stocks, and this is reflected in their high price/earnings ratios. As the price goes up, the P/E goes up. Record high P/Es are the result of investors' expectations of:

  • Strong earnings growth over the next five years
  • Continued low inflation
  • Continued bull market

Analysts predict the average annual growth over the next five years, and there is usually a correlation between the growth predictions for a company and its P/E ratio.

Company

P/E ratio

Estimated annual growth
for next 5 years
(%)

American Online Inc.

177

50

Microsoft Corp.

77

25

Pfizer Inc.

56

20

General Electric Co.

48

15

Proctor & Gamble Co.

45

13

Merck & Co. Inc.

30

12

Source: Fidelity Investments 1/18/00
These stocks are examples, and their inclusion on this chart is not an endorsement by Bankrate.com.

Now that you know what market capitalization is, you can use it to diversify your portfolio. And when you hear TV talking heads chattering on about P/E ratios and company growth, you'll be all over it.

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