The Morningstar Dictionary: Market capitalization

It's a fancy way to describe the market value of a company, but what does it really mean?

Christian Charest 17 March, 2017 | 5:00PM

 

 

Looking at a fund's name or reading a fund manager's strategy, you may have come across terms like large cap, mid cap or small cap, and you've probably figured out that it refers to the size of the companies they invest in. But what exactly is market capitalization? And what makes a stock or a fund land in one category or the other?

Simply put, market capitalization is the value of a company's outstanding stocks, which is to say, the market value of the company itself. It's calculated by multiplying the number of shares on the market by the share price.

For example, let's say Vandelay Industries has a share price of 120 dollars, and it has 150 million shares in circulation. That means its market cap is 18 billion dollars.

Does that make it a large cap? Index providers, fund managers and other industry players have different thresholds to determine whether a stock is small, mid or large cap.

The way Morningstar does it is to add up the total market capitalization of every company in a specific market like Canada, the United States or Europe, and ranking them in order of size. The largest companies that make up the top 70% of that market are considered large cap. The ones that make up the next 20% are the mid-cap stocks, and the bottom 10% are the small caps.

Note that the thresholds between two categories won't be the same in all markets. A company that's considered mid-cap in Canada would probably land in the small cap category in the US, for example.

As for mutual funds or ETFs, we show you not only the average market capitalization of a fund's holdings, but we also show you how many of them land in each section of the Morningstar Style Box.

Spreading your holdings among stocks of different capitalization levels is a good way to get diversification in your portfolio, since small caps and large caps typically present different growth and risk profiles. Large caps are usually less risky, but their growth potential is somewhat limited, whereas small caps give you the opportunity to get super-sized growth, but you may be in for a bumpy ride.

About Author

Christian Charest

Christian Charest