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Investing Basics: What’s Large Cap? Small Cap?

I know this is a common question for beginners. While I do have an investing glossary that explains any terms you might not be familiar with, it is beneficial to go more in depth with some of the terms. I saw a comment asking about the meaning of large cap and small cap, so here you go.

When you buy a stock you are investing in that company. As soon as you have a share, you now own part of the company. They then call you a shareholder.

As a shareholder, you have a right to part of the company’s profits. This is also known as a dividend. Smart investors buy for dividends.

How much of the company you own depends on two things. How many shares you buy, and how many shares outstanding the company has.

large cap

Shares outstanding is the number of shares available for purchase for a company. When you buy a share of stock, it comes from the shares outstanding.

Shares outstanding determines how the company is divided up. The number by itself means nothing.

But, shares outstanding is important in relation to how many shares you own.

For example, lets say you own 5 shares. For absolute simplicity’s sake, lets say the company has 50 shares outstanding. You then own 10% of the company.

What does this have to do with large cap?

Actually, it has a lot to do with large cap. So listen, and learn. The next part is also important.

You need to understand that there is more to a company’s market value than the share price.

A $1o stock is not necessarily cheaper than a $20 stock. Let me explain.

The market value of a company is determined by both the share price and the number of shares outstanding. Remember that shares outstanding determines how many shares are available to buy. The share price only shows at what price these shares trade at.

So the market value of a company is the shares outstanding multiplied by the share price.

Market value = [share price] x [shares outstanding]

To clarify things, let’s say Don’s Co. has 200 shares outstanding. Let’s say Don’s Co.’s stock trades at $15. The market value of Don’s Co. isn’t $15. It’s actually [15 x 200], which is equal to $3,000.

The stock market term for market value is market capitalization. And this is where everything comes full circle. 

Large cap simplify refers to companies with a large market capitalization. Small cap refers to those with a small market capitalization.

In layman’s terms, large cap means big companies. Small cap means small companies. Think Google (GOOG) when you think of large cap and WebMD (WBMD) for small cap.

Remember…

Market cap = Market value = [share price] x [shares outstanding]

Believe it or not, there’s actual specific ranges for large and small caps. There’s even mid and micro caps. For your convenience, I’ve listed them here.

Large Cap – $10B and higher
Mid Cap – $2B to $10B
Small Cap – $300M to $2B
Micro Cap – $300M and lower

You will most likely encounter these terms when sifting through mutual funds. Many of them have a focus on Large Caps, or even Mid or Small Caps. It’s up to you to determine what you want to invest in.

Large Caps tend to be more stable and have less growth. You may have also heard them referred to as Blue Chips.

Just because a company is a large cap doesn’t mean it won’t grow. When Walmart was at $20B, it was considered a large cap. I’m sure the investors didn’t mind when the stock went to $100B.

Small Caps are more volatile than Large Caps due to their smaller size. They also tend to be more risky, as some of them might not have as solid balance sheets or backgrounds as the Blue Chip Large Caps.

Invest in small caps at your own risk, and be sure you know what you are doing before you dive in. A book like The Intelligent Investor is a great place to start.

Beware This Novice Mistake

Like I said above, a company can determine how many shares outstanding to offer. At any time, it can double its shares outstanding in what’s called a stock split. This causes their share price to cut in half.

Nothing changes in value when a company does a stock split. It may seem like it, but this is a very common misconception among novices.

When a company does a stock split, it doubles the shares outstanding and halves the share price. Fundamentally nothing happens with the market capitalization.

The shares appear to be cheaper to novices, because the share price cuts in half, but nothing has really changed to the overall valuation. Since the amount of shares has doubled, this cancels out the halving of share price.

Make sure you understand how market capitalization works. Don’t be a novice and don’t get excited about stock splits.

**Investing Basics: What’s Large Cap? Small Cap?**
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