Stock Market Cap Analysis - Secrets For Building a Diversified Portfolio

It's important for investors to allocate their portfolios among all market caps to provide diversification, avoid cyclical returns, and take advantage of "regression to the mean" (e.g. one market cap segment outperforms another, but then they converge).

Stocks can be separated into 4 groups, according to their market capitalization:

1. micro caps - below $300 million
2. small caps - between $300 million and $1 billion
3. mid caps - between $1 billion and $5 billion
4. large caps - over $5 billion

Market Cap is calculated by multiplying the number of shares outstanding by the share price. For example, if stock ABC issued 6 million shares, and the price of each share is $6, then ABC has a market capitalization of $36 million.

Stocks within each market cap share important characteristics in the following areas:

1.Growth Rate - Small cap companies tend to be in growth mode because either they are selling a new product or service, or else they are well-established in a certain region and are looking to expand. This means that the stock price may appreciate a lot in the near future, as earnings and sales increase.

Micro caps haven't yet started to enjoy fast growth rates. They are still plodding along before they hit critical mass and take off. This means that investors willing to take more of a risk have a chance to jump on-board early, and catch the full move.

Large and mid cap stocks are usually past the stage of fast growth, but they have earnings stability.

2. Risk - Micro caps are the riskiest capitalization group because they are the most likely companies to lack stable cash flow, management talent, and infrastructure.

Small cap stocks are riskier than medium and large cap stocks because they may not have the deep management talent, clout, and lines of credit to weather strategic mistakes and/or down markets.

Mid cap and large cap stocks tend to have stable cash flow, talented management, and established product lines.

3. Dividends - Large cap and, to an extent, mid caps tend to pay dividends, making them attractive to investors (such as retirees) who need income.

4. Visibility - Large cap stocks tend to be widely held by institutional investors and followed by analysts. Thus, they are less likely to produce positive and negative surprises. Mid cap stocks may be less covered and thus occasionally offer opportunities to buy at great prices. Small and micro cap companies are less covered by Wall Street, and can offer many more hidden opportunities and pitfalls.

5. International exposure - Compared to small and micro caps, large cap and some mid caps tend to do business globally. This provides geographic diversification for their operations and earnings. They are able to capitalize by moving operations to low-cost countries, and tapping world-wide pools of talent. They are not as dependent on slumps in their home economies.

Success in stock trading depends on both stock selection and having a proven system for knowing when to buy and sell.

Praveen Puri has almost 20 years of trading and investment experience - including serving as a consultant to major insurance companies, banks, and the Chicago Board of Trade. He has a fully automated stock trading business that is boring, predictable, but extremely lucrative.