1.0 INTRODUCTION
We often hear companies or different mutual funds being
categorised as ‘Small Cap’ ‘Mid Cap’ or ‘Large cap’. What do these terms really
mean? The “Cap” part of these terms is a short form for
Capitalization.
Capitalization is a measure by which we can classify a company’s
size. Although the criteria for the different classifications are not strictly bound,
it is important for investors to understand these terms, which are not only
ubiquitous but also useful for gauging a company’s size and risk level.
2.0 OBJECTIVES
By the end of this note, you should be able to:
·
explain the concept of capitalistion
·
discuss types of Capitalization
·
explain the importance of capitalization.
3.0 MAIN CONTENT
3.1 Meaning of Capitalization
Capitalization refers
to the market value of a company’s outstanding shares. It is calculated by
taking the stock price multiplied by the total number of shares outstanding. It
is simply a fanciful name for a straightforward concept. For example, if Zenith Bank of Nigeria PLC was
traded at N20.00 per share, and the bank had three billion shares outstanding,
then the market Capitalization of Zenith Bank would be N20.00 x 3,000,000,000 =
N60billion (N60,000,000,000.00).
Therefore, we can conclude here that Capitalization is a product
of two parts, the market price of stock and the number of shares outstanding.
In the light of this, when the share price appreciates or depreciates (all other
things remaining constant) the Capitalization also increases or decreases with
respect to the share price.
3.2 Types of Capitalization
There are different types of Capitalization. While there is no
single framework for defining the different market Capitalization, here are the
widely published standards for each Capitalization:
1. Mega Cap: Based on information about the New York Stock Exchange, this group
includes companies that have a market Capitalization of $200 billion and
greater or more. They are largest companies, which sell their stocks to the
public such as EXXON (NYSE:XOM). Not many companies will fit into this category;
those that do are typically the leaders of their industries. In Nigeria, as of
2008 and 2009, companies like First Bank of Nigeria Plc have the highest Capitalization
on the Nigerian Stock Exchange. Thus, based on the Nigerian situation, it can
be regarded as a Mega Cap.
2. Big/Large Cap: These companies have a market Capitalization of between $10
billion to $200 billion. Many well-known companies fall into this category,
including companies like Microsoft, Wal-mart (NYSE:WMT) and General Electric (NYSE:GE),
and IBM. Typically, large cap stocks are considered relatively stable and
secure. Both mega and large/big cap stocks are often referred to as blue chips.
3. Mid Cap: This group comprises companies whose Capitalization ranges from
$2billion to $10billion. This group is considered more volatile than large and
mega-cap companies. Growth stocks represent a significant portion of the mid
caps. Some of the companies might not be industry leaders, but they are well on
their way to becoming one.
4. Small Cap: These groups of companies are typically new or relatively young
companies. Small caps have a market Capitalization between $300million and
$2billion. Although their records of accomplishment will not be as lengthy as
those of the mid and mega caps, small caps do present the possibility of greater
capital appreciation but at the cost of greater risk.
5. Micro Cap: This group comprise mainly of penny stocks. This category denotes
market Capitalization between $50million and $300million. The upward potential
of these companies is similar to the downside or downward potential; hence,
they do not offer the safest investment. Concerning the Micro Caps, a great
deal of research should be done before entering into such a position.
6. Nano Cap: This comprises companies having market Capitalization of below
$50million. These companies are the most risky with a relatively small
potential of gain.
Note: These ranges are not set in stone; they are prone to fluctuation depending
on how the market as a whole is performing.
3.3 Importance of Capitalization to Investors
A common misconception is that the larger the stock price, the
larger the company. Stock price, however, may misrepresent a company’s actual worth.
There are actually companies that are extremely capitalised but their stock
price is not among the highest. If we look at two fairly large companies, IBM
(NYSE:IBM) and Microsoft (Nasdag: MSFT), we can see that as of March 18, 2009,
their stock prices were $19.75 and $16.75 respectively. Although IBMs stock price
is higher.
If it has about 1.34
billion shares outstanding, while MSFT has 8.89 billion. As a result of this
difference, we can see that MSFT’s market Capitalization of $148.91 billion is
actually larger than IBM’s $122.95 billion. If we compared the two companies solely
by looking at their stock prices, we would not be comparing their true values.
This is because their true values are affected by the number of outstanding
shares each company has. Again, the classification of companies into caps
allows investors to gauge the growth versus risk potential. Historically, large
caps have experienced slower growth with lower risk. Meanwhile, small caps have
experienced higher growth potential, but with higher risk.
4.0 CONCLUSION
Understanding the market Capitalization is not just important if
you are investing directly in stocks. It is also useful for mutual fund
investors, as many funds will list the average ‘on’ median market Capitalization
of its holdings. As the name suggests, this gives the middle ground of the fund’s
equity investment, enabling investors know if the fund primarily invests in is
large, mid or small cap stocks.
5.0 SUMMARY
This note examined
the concept of Capitalization. It also looked at the different types of Capitalization;
mega cap, large cap, mid cap, small cap, micro cap and Nano cap. It then
finally discussed at the importance of Capitalization.
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