Market capitalization is a financial measurement of a size of a company. It is calculated simply as the company's share price times the number of outstanding shares. Investors use market capitalization to compare companies' worth and to help judge the value of their share prices. Large-capitalization companies give stability and are good long-term investments. Small-capitalization companies can produce faster growth and bigger returns, but their stockholders are exposed to more risk.
Mutual fund managers use market capitalization to evaluate new investment possibilities. Some mutual funds are designed to carry a certain amount of small-, medium- or large-capitalization company stock. Some analysts have expanded the categories to define market capitalization to include mega-, mid, micro- and nano-size companies, and mutual fund companies often use their own standards to categorize market capitalization, according to Fox Business. Market capitalization doesn't take into account a company's finances, experience of management, market developments, price-to-earnings ratio, product development, hiring plans or legal issues.
Large-cap stocks are preferred by investors who want less long-term risk, according to Investing Answers. The S&P 500 Index includes the top 500 market capitalization stocks in the United States. Because large-cap companies generally have more cash, they perform relatively well during recessions and have resources for future growth. Large-cap stocks sometimes provide added value by issuing payments to shareholders as dividends. However, big companies can have debt and pension obligations that slow down their performance during periods of higher interest rates and inflation.
Small-cap stocks are defined as those of companies worth between $250 million to $3 billion. The Russell 2000 Index tracks small-cap companies. Investors see rallies on this index as signs of an improving economy, because these small companies mainly serve U.S. markets. Because they are small, these companies have growth potential, but they also carry more risk. Small-cap companies generally hold less debt and are less vulnerable to interest rates, but their stocks are volatile and could suffer during market declines.
Small-cap shares go through a greater range of price changes than do large-cap shares, which show more stability. Small-cap stocks have more flexibility and can adjust their pricing and administration more quickly than large-cap companies, which have large administrations and set strategies that can be difficult to change. Because of this, it is harder for analysts to forecast earnings and future stock prices of small-cap companies.
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