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Friday, June 4, 2010

Market Capitalization - Small, Medium & Large Cap Companies

Story of Market Capitalisation

Market capitalisation of a company = Stock price X Number of outstanding shares.
Basically, market capitalisation (cap) is a way to classify companies in equity market according to their size. The market cap at any given point of time shows whether the company is either a large-cap or a mid-cap or a small-cap. With the rise in stock price and issue of additional shares into the market, the market capitalisation of a company goes up. As the market cap increases, the liquidity of the stock in the market also increases.

In the late 70s, Rolf Banz and Mark Reinganum, published a study that the companies with smaller capitalisation on an average gave more returns than the companies having larger capitalisation, even after adjusting for risk. This finding, also known as ‘the size effect’, has evolved into a style for managing funds.

The Bombay Stock Exchange (BSE) introduced ‘BSE Mid-Cap’ index and ‘BSE Small-Cap’ index on 11 April 2005 to represent and keep track of companies having size smaller than the 30 stocks listed on BSE Sensex. These indices denote the ups and downs in the mid-cap and small-cap sector.

                                           (Please click on the image for enlarge view)

There is no classical definition and clear differenciation of small-cap & mid-cap companies. It is based on the market capitalisation of the stock.

Large companies are fewer and bigger in India. Hence, the 50th stock and below in terms of capitalisation can be the cut-off to enter mid-cap space in the market. This is one of the definition used by most of the fund managers of various Mutual Fund houses.

The risks in terms of liquidity and impact cost increases as we move down the capitalisation curve.

Note: Apart from market capitalisation, investors need to bear in mind their individual investment goals, risk tolerance levels, financial health and their understanding of the security. Hence, to take an exposure to a small-cap or a mid-cap stock, recommendation from equity research analysts is advisable.