How Well Do You Know Market Cap?

Ever get a headline or an alert about a particular company's stock that has lost or gained a significant percentage of its value in a day?

That's a direct reference to the company's market capitalization—market cap for short.

And it's not just for headline writers. Professional portfolio managers and financial research firms with familiar names like S&P Global and Dow Jones^® rely on market cap to frame their analysis of companies old and new within specific industries.

Market cap represents the real-time value of any publicly traded firm based on shares of stock you could buy right now on the open market. Here's the market capitalization formula:

Now, let's go a little deeper.

A company's outstanding shares are a key element in fundamental analysis, illustrating the broadest number of a company's shares subject to daily valuation. That's why market cap is a good barometer to use to determine how a firm ranks against other competitors at any moment. However, it's also good to know the power dynamics within outstanding ownership numbers, which we'll get to below.

The thinkorswim^® platform provides a deep dive into company fundamentals. As shown in the image below, you can easily find any stock's real-time market cap in five steps:

Step 1: Log in to thinkorswim and select the Analyze tab.

Step 2: Enter a stock symbol.

Step 3: Select Fundamentals.

Step 4: Select By the Numbers and choose whether you want to see data on an annual or quarterly basis.

Step 5: Scroll to the bottom of the screen to view the stock's Total Shares Outstanding and Market Cap.

Any investor—professional or individual—can use market cap to group stock choices along a particular industry category or investment theme.

"Big moves in market cap get attention, but if you're investing in companies, market cap is just a starting point for what you'll need to know," said Viraj Desai, director, Charles Schwab Investment Management. "For example, larger-cap companies generally have a track record of long-term success and stability, so you'd want to watch how companies within that size range are performing as a group and why."

As for smaller-cap firms, risk comes into play, Desai noted. "Small-cap or micro-cap stocks are generally younger firms with relatively short track records that require deeper due diligence to determine their prospects," Desai added. "Market cap provides a shorthand for the way you'll evaluate companies—or groups of companies—as they grow and mature."

The Financial Industry Regulatory Authority (FINRA), the U.S. financial industry's self-regulatory body overseeing investment broker-dealers, categorizes market cap as follows:

•  Mega-cap companies have a market value above $200 billion.
•  Large-cap companies have a market value between $10 billion and $200 billion.
•  Mid-cap companies have a market value between $2 billion and $10 billion.
•  Small-cap companies have a market value between $250 million and $2 billion.
•  Micro-cap companies have a market value below $250 million.

"Both professional and individual investors can build their portfolios with market capitalization as a consideration for the goals they want to reach," Desai said. "Market cap can introduce you to choices that fit your risk appetite, investing time horizon, and market outlook."

Within the mutual fund, exchange-traded fund (ETF), or investment management world, market cap can often reveal other insights. "If you see a particular manager with a few small-cap holdings in what's supposed to be a large-cap fund, that's what's called 'style drift,' and it is frequently used to generate excess returns," he explained. "The problem is that too much style drift can violate the fund's objective."

That's why market cap should just be "a starting point" for your stock analysis—the first stage of a filter that narrows down your universe of asset selection, according to Desai.

Most of the major stock indexes, such as the S&P 500^® index (SPX) or Nasdaq-100^® (NDX), are market-cap-weighted, meaning stocks are selected and tracked based on their real-time market caps. To be included in such an index, a company needs to maintain a market cap that exceeds the index's minimum value. For example, the minimum market cap for inclusion in the SPX is currently $14.6 billion, according to S&P Global.

If a company's share price falls and its market cap is below the index's minimum, the company usually has 30 days to raise its market cap above the minimum or face potential elimination from the index. Such index additions and subtractions are common and require a replacement stock and a rebalancing of the overall index based on the new addition.

However, market-cap-weighted indexes are not the only game in town.

One drawback of market-cap-weighted indexes is that they can be prone to concentration risk, which means that an index may be overweight based on the performance of a small number of companies within the group. For example, the top 10 holdings of the SPX accounted for more than 30% of the total index as of the end of October 2023.

Some investors prefer to check what are known as equal-weight indexes, where each stock in a major index is weighted by an equal percentage, decreasing the risk of a small handful of stocks dominating an index's performance. For example, in the S&P 500 Equal Weight Index (SPXEW) each stock accounts for 0.2% of the total index. Given the high concentration in the market-cap-weighted SPX, an allocation to an equal-weighted index can diminish the risk of overconcentration, while allowing you to still access the pool of companies that make up the SPX. 

In early September 2023, Apple's (AAPL) stock price lost nearly 10% over two days after the Chinese government decided to strengthen its ban on state employees using Apple products. Given the size of the Chinese market and the popularity of Apple's products in China, the announcement dealt a serious blow to the company's valuation. While stocks can recover, sudden moves in market cap can be a worthwhile trigger that it's time to do more research on a company's future prospects.

Learning new investment tools is important, but all have their limitations. Here are a few to consider as you use market cap to invest:

• Market cap reflects only one side of the balance sheet. Market cap tracks equity movements only, and investors also need to understand how a firm's outstanding debt and other liabilities affect its prospects. So, market cap is a great starting point to evaluate a company's size, but it's also important to consider a range of fundamental metrics, such as earnings, earnings growth, and leverage.
• Market cap dominance can foil diversification. We brought up concentration risk earlier—the potential for the largest stocks in any market cap category to hurt their peers if their news turns bad (see figure 2). When investing in individual companies or funds, it's important to understand market cap weighting and the impact market cap leaders you own could have on the rest of your investments. After you check a company's profile information on thinkorswim, consider bookmarking the SEC's EDGAR database to search for the latest company financial information filings to tell you more.
• Market cap challenges professional investors too. Recall that style drift occurs when a fund manager invests in securities that are beyond the manager's mandate, such as adding large-cap investments to a mutual fund or ETF of mid-cap stocks. Individual investors run the same risk of being susceptible to style drift. If you've laid out a stock allocation plan that focuses on market cap, you need to make sure the percentage of assets allocated doesn't stray too far from your target asset allocation. This may require occasional rebalancing of your portfolio to put it back in line with your overall investing allocations. Also, get to know the concept of tracking error—a measure of difference in returns between a stock or mutual fund and its benchmark. It's a potential indicator of style drift too.

Market cap is a solid first indicator to help you evaluate a potential investment's market value. You can use it to measure investments against your risk tolerance and growth targets as you build a portfolio over time. However, it's important to dig a bit deeper to get the full picture of a stock's or fund's individual performance. You'll find thinkorswim provides hundreds of studies and data points to help you do just that.