While many new investors believe that a company’s stock price is important when buying, what they should be looking at is the company’s price tag
A quick summary:
- To determine the size of a company, look at “market capitalization” (market cap, for short).
- Market Cap = Number of shares outstanding multiplied by share price.
- Market cap sizes range from nano, micro, small, mid, large and mega.
Ok, but let’s look deeper
New investors often fall into the trap of equating share price with value. In reality the two are completely independant of each other. The share price is actually of very little consequence. As we will see later with stock splits, a company’s share price is dependent on how many shares are in the market at any given time.
Let’s take the example of McDonald’s and Chipotle Mexican Grill. A stock in Chipotle currently costs around six times that of McDonald’s. So which is the bigger company?
Chipotle is a great company that has been expanding rapidly, but it’s nowhere near competing at McDonalds’ level just yet. To get the figures, we look at the market capitalization of each company. We can work that out by looking at the current share price and multiplying it by the number of shares in the market.
Chipotle has around 31 million shares in the market right now, making the company worth $18.5 billion. McDonald’s on the other hand has almost a billion shares, giving them a value (or market cap) of over $100 billion.
So what does this mean for investors? Shouldn’t you just invest in the most valuable companies?
It all depends on what your goal is as an investor. The more valuable companies are much safer investments. Apple, Google, and Disney aren’t going anywhere anytime soon. You’re pretty much guaranteed that you won’t lose all your money on these guys.
The flipside is that these companies aren’t going to grow as fast as smaller companies like Chipotle, iRobot, and SolarCity. These companies have more room to expand and therefore could see huge rises over the next few years. Of course, that also makes them riskier investments.
So you’re making a trade off between risk and reward. The more volatile a company, the greater the potential for growth. The more secure a company, the less the chance of quadrupling your money.
There are six levels of market capitalization.
- Mega Cap (least risk/slowest growth): $200 billion and greater
- Large Cap: $10-$200 billion
- Mid Cap: $2 billion to $10 billion
- Small Cap: $300 million to $2 billion
- Micro Cap: $50 million to $300 million
- Nano Cap (most risk/fastest growth): Under $50 million
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