As an investor in the stock market, you should have some rules or guidelines that you follow to focus your research within particular parameters.
These don't have to be "set in stone," although many institutional investors and many mutual funds do have specific guidelines for investing. For example, an institutional investor may have a rule that says we won't invest in any company that doesn't pay a dividend.
One parameter that is important you to consider is company size. This doesn't mean you only invest in one size, however some investors hold fast to this rule.
Their reasoning is size is important in market dynamics and assessing risk.
Company size is just one aspect to consider when evaluating a stock; however, it is important because large and small companies react differently in the market. See Tools of Fundamental Analysis.
Let's define size before going any further. There are two ways you can classify a company by size: revenue and market capitalization.
Most people don't use revenue because differences in industries distort how large or small a company is based solely on revenue. After all, it is earnings not revenue that ultimately determines a company's worth in the market.
Market capitalization or market cap is the standard measure of company size. You compute market cap by multiplying the number of outstanding shares by the current stock price.
For example, if a company had one hundred million shares of common stock outstanding and a current stock price of $55 per share, its market cap would be $5.5 billion (100,000,000 x $55 = $5.5 billion).
This calculation lets you do an "apples to apples" comparison with any two or more companies.
You can find the market cap of any stock reported on most quotes you find on the Internet such as Yahoo! Finance. Simply enter a symbol and the market cap is among the data reported.
Investors categorize companies by market cap and place them under one of these labels - although there is not universal agreement on the exact cutoffs.
- Micro Cap - $300 million and under
- Small Cap - $1 billion and under
- Mid Cap - $8 - $1 billion
- Large Cap - $100 - $8 billion
- Mega Cap - Over $100 billion
These are completely arbitrary and you may well see other rankings elsewhere. Many people only use three: small, mid and large.
I've come to like these five because of the two high and low extremes. Investing at these two levels is so different that it warrants separate categories.
In the Mega Cap category, you have companies like Apple and Mobil-Exxon and in the Micro Cap category, you have the (name one).
If you invest in the micro and small cap markets expect volatility and failure. These numbers ($300 million - $1 billion market caps) may sound impressive, but they are most like gnats on elephant's butts. Many have life spans about that long. See Understanding Risk.
At the same time, mega cap companies were once both small and could easily have gone under (Apple almost did in the 1990's). While there is great risk in the micro and small cap market, there can be great reward.
A company's survival is not guaranteed by size; however, it helps to be a fairly large fish if you are going to swim in the big pond. Small companies are risky investments, but can pay big rewards.
For most investors (not retirees or near-retirees), a small percentage of your investments should be in the micro - small cap area. This is money you are betting on for a big score.
If you are nervous about picking, micro or small cap stocks, consider a low cost mutual fund or exchange traded fund as an alternative.
