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Everything You Need to Know About Market Size


There is a lot of talk, especially lately during one of the longest bull markets in history, about market size.
Of course, to the casual investor, market size doesn’t really mean a whole lot.
Bigger numbers are better, numbers going up is good, and everyone on television celebrates when the markets hit arbitrary numbers.
But what do all of the numbers mean and what does market size have to do with investing?
There are a number of ways to look at market size and this article will examine those concepts, put them into real terms that investors can understand for their own portfolio management, and help clear up a lot of the mystery and confusion that can surround these concepts regarding market size.

What Do the Market Size Numbers on Television Mean?

Many people get their market news from quick television news pieces.

Perhaps your local news channel has a short piece every night with market news and updates. The anchor will say something like, “A great day on the markets as the Dow Jones Industrial Average jumps 250 points to end the day at a new high.”

To many people, that sounds like good news but they may have no idea what any of that information actually means. Up is good, a new high is good, and green looks nice if you are an investor.
Many people use indexes like the Dow Jones Industrial Average or the S&P 500 to measure market performance and growth. However, these numbers should not be conflated with market size. These indexes simply track the price and performance of a selected group of stocks.

For example, the Dow Jones Industrial Average uses the stock prices of the 30 largest publicly traded companies to build the average. That means that a vast majority of stocks are not considered when building the average.

However, it does stand to reason that when the biggest companies are doing well, so are many of the companies that are not considered as part of the average. It would also stand to reason that if the Dow Jones Industrial Average is growing then so would the overall market.

The S&P 500 uses the market capitalization of 500 large, publicly traded companies to determine the size and performance of the index.
While using the market capitalization of companies does better indicate market size, the limited sample excludes a wide range of companies and may not directly correlate to the size or performance of the overall market.

Determining Market Size of Public Companies

Another term investors often hear thrown around is “market capitalization.”
This number, in essence, refers to the market size of any publicly traded company. Determining market capitalization is quite easy. All you have to do is multiply the number of outstanding shares by the price per share.

This simple number is a great way of comparing the market size of companies. It is an especially popular analysis tool when comparing companies in the same industry.
Market cap can also be used to track the growth or decline of a company’s market size over time.

In the investing world, you will often hear about small cap companies, mid cap companies, and large cap companies. The number are somewhat varying based on who you speak to. Generally, small cap companies have a market capitalization of less than $2 billion while large cap companies have market caps of over $10 billion.

Finding small cap companies with the potential to become large cap companies is a great way to build value in a portfolio.
One of the best examples of a small cap company becoming a large cap company and one of the most well-known brands in the world is Netflix. Today, Netflix has a market cap of over $100 billion which is massive growth from a decade ago when Netflix was considered a small cap company.

Of course, companies can head in the other direction as well. Market cap is a good indicator of a company’s strength and role in the market, but it does not make them immune to challenges. Enron is one of the most famous examples of a company going from large cap to small cap to being delisted entirely from the New York Stock Exchange. All of this happened within one year, and, of course, was aided by scandal and fraud.

Investments Also Have a Market Size

Investment funds like mutual funds or index funds are also looked at based on market size. This is especially true in recent years with the rapid growth of index funds. In fact, it is estimated that index funds could soon own nearly 30% of the entire U.S. stock market with massive funds like Vanguard, BlackRock, and State Street leading the way.

How should you factor market size of companies or funds into your investment decisions? This information is just one way to examine assets and determine what is right for you.
In general, companies or funds with a larger market size are more likely to be safe, predictable investments; while small cap stocks and funds are often targeted by investors for growth.

Of course, there are exceptions to every rule and market size should not be the only way you guide your investment decisions. If you have more questions about market size, please contact Linden Thomas and Company.

Linden Thomas & Company

One of America’s Top Wealth Managers builds a better Index

At Linden Thomas, we believe most indexes focus on the wrong things like weighting the index based on the size of a company (market cap).

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