You’ve heard the terms before – small cap companies, large cap companies, companies that have virtually no cap, also known as start-ups.
While such terminology doesn’t challenge those who work in the markets on a daily basis, they can be confusing to the rest of us. Because the definitions between various levels of capitalization – that’s what cap means – have evolved. What once were small cap firms are now very much in the large cap category, without anything but their numbers having changed.
Capitalization, Defined
First, let’s define the term capitalization. It’s simply the aggregate worth of a company in the marketplace – the number of shares outstanding multiplied by the price per share. This can and often does differ from the book value of a company, which is the value of the company’s assets on the books divided by the number of shares outstanding.
Think of a house on the open market – it’s worth what someone will pay for it, rather than what someone has invested in it. Sometimes it’s not fair or even reasonable – there have been companies valued at billions of dollars of capitalization that hadn’t even put out a product yet – but it is what it is, and we’re stuck with it as a standard of valuation.
And for the most part, because the markets are for the most part a pure and effective means of valuation, it’s a useful tool for investors.
Small Cap, Defined
Today the category of “small cap” companies includes those whose total capitalization is between 300 million and two billion dollars. And while that seems like a lot, it’s relatively small in comparison to Blue Chip firms (like General Motors and IBM) that are valued at over ten billion dollars, and there are literally hundreds of them out there.
Why delineate at all? Because there are mutual funds that define themselves by the type of companies they invest in, and small cap companies can represent a unique growth opportunity in the market place.
Small cap companies are established, they aren’t start-up enterprises, which means they’re well beyond the initial risk period that comes with the launch of a new venture. And yet, they haven’t yet matured to the point where their markets are saturated or their products have stiff competition, creating an upside limited only by their ability to navigate their niche and continue to innovate and serve their customers.
Astute investors often focus on a specific category or niche, and small caps, while not without risk, present a significant upside opportunity for those who can weather the inevitable storms of growth.
