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Sunday, June 5, 2011

Company Size Matters in Investing

In investing, like many other things, size does matter. Some investors limit their selections to certain size companies, while others spread their money across the size spectrum.

Company size is just one aspect to consider when evaluating a stock; however, it is important because large and small companies react differently in the market.

Let’s define size before going any further. There are two ways you can classify a company by size: revenue and market capitalization.

Defining Size

Most people don’t use revenue because differences in industries distort how large or small a company is based solely on revenue.

Market capitalization or market cap is the standard measure of company size. You compute market cap by multiplying the number of outstanding shares by the current stock price.

For example, if a company had one hundred million shares of common stock outstanding and a current stock price of Rs. 45 per share, its market cap would be Rs. 4.5 billion (100,000,000 x 45 = Rs. 4.5 billion).

This calculation lets you do an “apples to apples” comparison with any two or more companies.

Finding Market Cap

You can find the market cap of any stock reported on most quotes you find on the Internet such as rediff money. Simply enter a symbol and the market cap is among the data reported.

Investors categorize companies by market cap and place them under one of these labels – although there is not universal agreement on the exact cutoffs.

• Micro Cap

• Small Cap

• Mid Cap

• Large Cap

• Mega Cap

Many people only use three: small, mid and large.

We have come to like these five because of the two high and low extremes. Investing at these two levels is so different that it warrants separate categories.

In the Mega Cap category, you have the Reliance and Infosys and in the Micro Cap category, you have the (name one).

Expect Volatility

If you invest in the micro and small cap markets expect volatility and failure.

At the same time, Reliance and Infosys were once both small companies that could easily have gone under. While there is great risk in the micro and small cap market, there can be great reward.

A company’s survival is not guaranteed by size; however, it helps to be a fairly large fish if you are going to swim in the big pond. Small companies are risky investments, but can pay big rewards.