By Peet Serfontein
Market capitalisation, commonly referred to as market cap, is the total value ascribed to a company by the market - providing insight into its absolute size. This metric is used to categorise equities into large-cap, mid-cap, and small-cap tiers, each offering distinct advantages, growth prospects, and risk profiles.
What is market capitalisation?
A company's share price alone does not tell you much about the overall value or size of a company. This is because different companies have different numbers of shares in issue. Rather, market capitalisation reflects the total value of a company's outstanding equity in the market. It is calculated using the following formula:
Market Capitalisation = Outstanding Shares x Current Share Price
It encapsulates the market's perception of a company's size, stability, and potential. While market capitalisation does not directly measure intrinsic value, it provides a broad perspective on how a company stacks up relative to its peers.
Market capitalisation also helps investors understand a company's position within the broader economy. For instance, larger companies with substantial market capitalisation are often leaders in their industries and are perceived as stable investments and smaller companies, while riskier, may offer significant growth potential. Understanding these categories - large-cap, mid-cap, and small-cap - is essential for effective equity analysis and portfolio management.
Large-cap equities
In the United States (US), large-cap equities are companies with a market capitalisation exceeding $10 billion but in South Africa, they are typically the largest 40 companies listed on the Johannesburg Stock Exchange (JSE) (currently with market caps above R38 billion) but we would include companies with market values above R20 billion as large-cap as well. These firms are typically household names, known for their established operations and significant influence in their respective industries.
Large-cap equities are the backbone of many investment portfolios due to their perceived stability. These companies often operate in mature industries such as technology, healthcare, and consumer goods. Their extensive resources enable them to withstand economic fluctuations and maintain above average consistency in performance.
Examples of large-cap companies include Shoprite, Prosus and FirstRand. These companies have a strong market presence, robust financials, and a history of delivering shareholder value.
Large-cap equities offer stability and lower volatility, making them suitable for risk-averse investors. They are also more liquid, meaning they can be traded easily without significant price disruption. However, the primary drawback is their limited growth potential. As mature companies, their growth rates tend to be slower than those of smaller, more agile competitors.
Mid-cap equities
Mid-cap equities are companies with a market capitalisation between R2 billion and R20 billion. These firms are often still in a growth phase, transitioning from smaller to larger-scale operations.
Mid-cap equities offer a unique combination of growth and stability. They often operate in industries experiencing rapid innovation, such as renewable energy, biotechnology, or technology services. Mid-cap companies have more room for expansion compared to large-cap firms, making them attractive to investors seeking growth opportunities.
Despite their growth potential, mid-cap equities are generally less risky than small-cap equities. They are established enough to have some financial stability, yet small enough to adapt quickly to market changes. This balance makes them an appealing choice for investors looking for moderate risk and higher returns than large-cap equities typically offer.
Example of mid-cap companies are private education provider, ADvTECH, hotel provider, City Lodge, and food producer, RFG.
Mid-cap equities are well-suited for investors seeking a blend of growth and stability. However, they are not without risks. These companies may lack the extensive resources of large caps to weather economic downturns, making them more vulnerable during periods of market volatility.
Small-cap equities
Small-cap equities are companies with a market capitalisation of less than R2 billion. These firms are often in the early stages of development or operate in niche markets.
Small-cap equities are known for their high growth potential. These companies often focus on innovation and operate in fast-growing sectors, such as emerging technology or specialty manufacturing. Due to their smaller size, they can be highly agile, adapting quickly to changes in market conditions or consumer preferences.
However, small-cap equities are also associated with significant risk. They are more volatile than larger companies and often face challenges such as limited access to capital, lower liquidity, and greater sensitivity to economic fluctuations. These factors make small-cap equities a high-risk, high-reward investment choice.
Examples of small-cap equities in South Africa include emerging miners, Orion and Copper360, and niche property developers, Balwin and CalgroM3.
Small-cap equities can deliver exceptional returns, especially during periods of economic expansion or when operating in high-growth industries. However, their higher volatility and vulnerability to market downturns means that they are best suited for investors with a higher risk tolerance.
Why market capitalisation matters
Market capitalisation is more than just a measure of size - it provides critical insight into an equity's risk profile, liquidity, growth potential and performance through economic cycles.
The choice between large-cap, mid-cap, and small-cap equities depends on several factors, including an investor's risk tolerance, financial goals, and investment horizon. Conservative investors may prioritise large-cap equities for their stability and reliable returns, while those with a moderate risk appetite might favour mid-cap equities, while aggressive investors seeking high-reward opportunities could allocate a portion of their portfolios to small-cap equities.
It is also essential to consider market conditions when selecting equities. For example, during a bull market, small-cap and mid-cap equities may outperform due to their growth potential. Conversely, during a bear market or economic downturn, large-cap equities can provide a safer haven for investors.
A well-diversified portfolio typically includes equities from all market cap tiers. Large-cap equities provide a stable foundation, mid-cap equities offer growth potential, and small-cap equities add a speculative edge. By diversifying across market capitalisation categories, investors can mitigate risks and enhance the overall resilience of their portfolios.
