Stock Cap or Market Cap
A measure of company size - and survivability!
Stock cap or market cap (both abbreviations of stock market capitalization) is the current share price of a company multiplied by the number of shares issued by the company. It is an indicator of the size of a company - and its survivability!
Market capitalization is used to classify companies in terms of size. The order from the smallest companies is: micro cap to small cap to mid cap to large cap.
Of course, because the stock price varies on a daily basis, so does the stock cap or market cap.
But this daily variation is usually not that great to turn the company from say, a small cap to a mid cap, or from a small cap to a micro cap. But over time this may happen.
How do I use this number? I generally only consider companies with a market cap greater than A$100M. I multiply this by a factor of 10 for U.S. companies as it is a much larger market.
So when I use a stock market screener to find wonderful companies, I use 'market capitalization greater than A$100M' as one of the filters.
Smaller Size Means Greater Risk
So why do I screen out small companies? Some small companies below the A$100M level are too young to have five years of financial information to base a valuation on.
As a value investor, I need that information to help determine the intrinsic value of the company in question.
Also, companies under this level are less able to absorb the shocks that most companies endure from time to time. Small companies have fewer resources to fall back on. So they go belly up more often!
Bigger Not Always Better
However, a negative thing (for me) about larger companies is that the larger the size of a company, the greater the number of market analysts who study them.
Big companies and major banks have a stack of analysts checking and making a share market forecast about them.
Consequently, the share price of larger companies, at any time, is more likely to be greater than the intrinsic value of the company.
Why greater than? Larger companies tend to be overvalued more often than not because active fund managers and superannuation fund managers generally have buckets of money that have to be invested.
They also need liquidity in their investments when dealing with large sums of money. Larger companies are more liquid. That is, more people are buying and selling their shares.
So fund managers can buy large companies without too much impact on the share price ... and also get out reasonably quickly when they want to.
Also, some fund managers are constrained by investment policies that require them to only invest in companies over a certain size.
Interestingly, companies in the A$100M - A$500M range (mid caps) often don’t have any analysts looking at them. There is greater potential that the share prices of these companies may drop below their intrinsic values.So guess where I find the best investments more often? ..... You guessed it - in the medium-sized (mid cap) companies.
And historical studies do show that these medium-sized (mid cap) companies offer better value. Hence I am more likely to enhance my financial performance by having some of them in my portfolio.
As value investing is an approach which is about risk minimization, I steer clear of the small stock caps such as penny dreadfuls, micro caps and most small caps.
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