Episode #6 - Caps for sale, three different types of caps!
More about portfolio diversity and how it relates to "caps"
Intro:
Well, we’re back - to think a week off for Memorial Day and we’d be in a totally different world…it seems that happened. I wish for health, safety, and justice in the world, and at home.
This image might look familiar from a couple of weeks ago. As you can see, this time I’ve used my handy Instagram photo-editor to circle Zoom’s mkt cap of 36.66 billion dollars. If you follow the link in the photo this morning, you’ll see that we’re now at 50.61 billion dollar market cap. Zoom has put on $13,950,000,000 in market cap since it was last featured in this letter (that is six JetBlues). Quarantine food-intake jokes aside, that is A LOT of billions to add in just a couple of weeks.
However, before we even get to talking about those billions, I want to introduce you to today’s topic - Market Capitalization (affectionately known as market cap). What does it come from? What does it mean? And, as always, why should it matter to you?
Background:
Zoom serves as a useful example, mainly because we use it all the time these days, but also because it reflects an exciting market cap related situation that transpired over the past weeks - it went from mid-cap to large cap, basically overnight.
Before we get rolling, let’s start with the definition of market capitalization:
it is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share. (thx, Investopedia!)
Based on Zoom’s current price of $179.50/share we’d learn that there are 281,949,860.72 outstanding shares of Zoom on the market being bought and sold all the time. That’s a lot of Zoom. More significantly, a year ago Zoom had a $6 billion market cap (squarely in the mid-cap world, see Into the weeds below) and now it sits squarely in the large-cap world.
When do you first find out about a company’s official market cap? That happens during the Initial Public Offering (IPO), when a company joins the stock exchange of it’s choice. The exact amount of money a company is evaluated at during it’s IPO will appear as its trading price, but once it’s on the market supply and demand will decide the company’s value and it’s market capitalization.
Into the weeds:
If you’re thinking, wait a second, market capitalization is not the same as a company’s true “value” - you’re not alone. It is a misconception that when a company has a high market cap it’s worth a lot of money, though it does mean the stock is valuable.
On the market it might appear that it is valuable, but that is likely based on future value that the investors in the company hope to take advantage of by getting the stocks BEFORE the company’s actual value hits what the market capitalization calculation equals. For example, Zoom has put on the value of seven airlines COMBINED since Covid-19, that’s a lot of cap to gain in such a short period of time when not that much has changed in Zoom’s fundamentals: it’s an enterprise video conferencing software suite with bad UX/UI.
As a part of our Zoom thought experiment, if a new company hits the market, or if Google figures out how to make Hangouts, Meet, or whatever they call their video conferencing software to actually kick-butt, Zoom may just zoom out of our minds and into the dustbin of enterprise software history. Point here is that market cap is an indicator, but it’s not the final verdict on a stock.
For our purposes we can leave Zoom in the dust and focus on the question of multiple caps. There are three types of market capitalizations that we’ll review and each one can have different impacts on your portfolio:
Large-cap: These companies are the largest publicly-traded companies on the market. Household names like Microsoft, Apple, and Amazon top these lists these days, but in the past you’d expect to see General Electric, and Berkshire Hathaway still appears in the top ten these days. They usually have market caps above $10 billion, but that’s kind of based on old info because Amazon, Apple, and Microsoft are all worth over $1 trillion. Don’t be fooled, these companies can crash, and when they crash, they crash hard. They don’t grow at the same rate as the mid and small-cap stocks you’ll see below, but you typically buy them assuming they’ll play the “ole reliable” tune in your portfolio.
Mid-cap: Typically valued between $2 and $10 billion and will take more risk for the investor than a large-cap company. As our friends at Investopedia say “Mid-cap companies are established companies that operate in an industry expected to experience rapid growth. Mid-cap companies are in the process of expanding.” Making sure you have some of these in your portfolio enables you to benefit when a company in a new market starts to hit her stride.
Small-cap: Typically sits in the $300 million to $2 billion range and are typically viewed as high risk because they are newer in the market and have not established themselves in the field. Their growth potential might be higher (they can become more established mid or large-cap stocks in the future) but right now they are on the small side.
Apologies for the winding road through the weeds, but, as you can see, having stocks from each of these caps would serve different purposes to your risk profile and hopefully for your long-term financial security/risk/growth.
Takeaway:
Find yourself a few different caps, and rotate them. No, not just because you’re a fair weather fan and will only wear a Knicks beanie when they reach the playoffs (i.e. you have a dusty Knicks beanie). You want to find a mix of these stocks, again, through your own choosing (not advised) or through a concoction of ETFs or mutual funds that specialize in particular “caps.” With the many market caps, you expose yourself to different types of risk as well as different types of reward.
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Up next:
Finally we’ll discuss the difference between Mutual Funds and ETFs and which you should buy!