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When it comes to investing, the general consensus is that size matters and shares of stock in larger, established companies are typically a safer bet than shares of smaller companies. The flip side is that small companies usually have more room to grow and you might be getting in on the ground floor of a great investment.
Companies are broken down into categories based on their capitalization. A company’s capitalization is calculated by multiplying the price of one share of stock times the number of shares there are. Here is the breakdown for each category:
- Large-cap stocks – Capitalization of more than $7 billion.
- Mid-cap stocks – Capitalization of between $1 billion to $7 billion.
- Small-cap stocks – Capitalization of under $1 billion
- Micro-cap stocks – Capitalization of under $300 million
P/E Ratio
Size by itself doesn’t tell you much about a company’s stock. The price-to-earnings (P/E) ratio is a useful tool that is commonly called upon to evaluate a stock.
The P/E ratio is calculated by taking the price of a stock and dividing it by the company’s yearly earnings.
For example, if a stock is currently selling for $30 and it has yearly earnings of $1 per share, the P/E ratio is 30. Remember that a company’s dividend is different from its earnings. A company may choose to pay out only a portion of its earnings as a dividend or none at all.
Here are some things you should know about the P/E ratio:
- It changes every day as the stock price goes up and down.
- It changes as earnings increase and decrease.
- It is helpful to compare the P/E ratios of companies in similar industries, since their P/E’s should be in the same ballpark.
When a company has an unusually high P/E ratio as compared to years gone by, it may indicate that the company is overpriced and ready to fall in value. An unusually low P/E ratio may indicate the stock is cheap or it may be a sign that the company is weak and has a higher risk of filing for bankruptcy.
Value vs. Growth >> |
