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Diversifying by Company Size
Three Caps Are Better Than One
Diversifying by company size, or market capitalization, also known as "market cap," is an important component of a broad stock market strategy. You may want to talk to your financial advisor to make sure that you're not over- or under-weighting your portfolio with large-, mid-, or small-cap stocks. There's no sure way to predict which cap will be the rage from one year to the next. So to manage your portfolio risk, clear ample shelf space for all three.
The Difference
By looking at how much a company's stock is worth, market capitalization is one way professional investors distinguish one stock from another and evaluate potential trading characteristics.
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- Large-cap US stocks are the 1000 companies with the largest market capitalizations in the United States. They are represented by the Russell 1000® Index* and have market caps of more than $1.4 billion.
- The Russell Top 200™ Index represent the largest of these, with market caps that range from $11 billion to $400 billion. These 200 largest stocks alone represent about 60% of the US market.
- Mid-cap stocks are the other 800 companies of the Russell 1000® Index. With market caps ranging from $1.4 billion to $11 billion, they represent nearly 30% of the market.**
- Small-cap stocks are the next 2,000 largest companies. With market caps of less than $1.4 billion, they represent 10% of the market. (Companies smaller than small cap are called micro-cap stocks).
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Mid-Cap Characteristics
Mid-cap stocks may seem attractive to investors for a couple reasons. One is that mid-cap stocks aren't closely scrutinized by as many analysts as the Russell Top 200 stocks. Another is that they are livelier than the very largest of the large-cap stocks but are less risky than small-caps. However, mid-cap stocks are no more likely to outperform over the long term than larger or smaller companies.
Small-Cap Characteristics
Small-cap stocks expose your money to a wider range of investment opportunities. Because small companies fail more often than larger businesses, small-cap stocks tend to be more volatile. Investors seeking the return potential of small caps have to be willing to accept more fluctuation in the value of their investments.
By allocating a percentage of your investment to small caps and mid caps, you're complementing your large cap exposure, which adds another element of diversification to your asset allocation strategy.
Calculating Market Capitalization
Calculating a company's market capitalization is one way to estimate a company's worth because a buyer would have to pay at least that to buy the entire company.
Performing this calculation is easy — just multiply the number of outstanding company shares by the share price.
For example, a company with a million shares outstanding and a share price of $20 has a $20-million market cap — the market value of the company's equity.
* This is how Russell Investments Canada Limited divides the market by capitalization. Some observers define large-cap companies as the 500 largest US companies.
** Source: Russell Investments Canada Limited, based on the public companies in the Russell 3000® Index, as determined May 31, 1999.
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