What it means
Market capitalisation is the total value of a company's shares, found by multiplying the share price by the number of shares in issue. Companies are grouped by size into categories such as small cap, mid cap, large cap and megacap.
The megacap label sits at the very top, though the exact cut-off varies between index providers and analysts. In many share indices, weights are based on market capitalisation, so the biggest companies have the biggest influence.
A handful of megacaps can therefore move an index noticeably even when most other shares are flat. Investors who hold an index fund own a large amount of these companies whether they intend to or not.
Megacaps tend to have wide international operations, large cash flows and strong credit ratings. They can often borrow cheaply, spend heavily on research and acquire smaller rivals.
These advantages can reinforce their position, but size also brings scrutiny from regulators and limits how fast the business can grow in percentage terms. For a finance professional the key point is concentration.
When a few companies make up a large part of an index, a portfolio that appears diversified may carry more risk than expected. Fund managers sometimes compare a standard index with an equal-weighted version to see how much is down to the giants.
The category also matters for liquidity, meaning how easily shares can be bought and sold. Megacap shares typically trade in high volumes with narrow price gaps between buyers and sellers, so large orders can be filled with less effect on price.
Remember that market capitalisation changes every second with the share price. A company can move in and out of the megacap group during a single volatile year, so classifications are a snapshot and not a permanent label.
In practice
Real-world examples.
Example
An index fund manager notes that the five largest companies make up 25% of a major index. She explains to investors that the fund is therefore heavily exposed to these megacaps. She offers an equal-weighted alternative for clients who want less concentration.
Example
A pension fund trustee reviews a mandate for large-cap shares and realises that most of the money has gone to a few megacaps. She asks the manager to set a limit on any single holding. The limit reduces the effect of one company's bad year on the scheme.
Example
A treasury team at a megacap company issues bonds worth $5,000,000,000 and finds that demand is several times the amount offered. Investors view the company as very safe and accept a low interest rate. The financing is completed within a day.
Formula
Calculation
Market capitalisation = Share price x Number of shares outstanding
Suppose a company has 1,000,000,000 shares outstanding and its shares trade at $250. The market capitalisation is 250 x 1,000,000,000 = $250,000,000,000, which is above a commonly used megacap threshold of about $200,000,000,000. If the share price falls 20% to $200, the value becomes 200 x 1,000,000,000 = $200,000,000,000, which is right at the boundary. A 20% fall in price therefore removes $50,000,000,000 of market value.Case study
Seen in the real world.
Windward Asset Management is an illustrative, fictional fund house that runs a global equity fund. Its analyst, Tomas, noticed that three megacap companies made up 18% of the fund's value.
When one of them fell 25% after disappointing results, the fund lost 0.25 x 6% = 1.5% from that single holding, since the company was 6% of the fund. The fund fell by more than its peers that year, and clients asked why.
Windward introduced a rule that no single holding could exceed 5% of the fund and explained the change in its next report. The illustrative lesson is that size does not remove risk, and concentration in giants can hurt as much as concentration in small companies. The analyst also recommended that clients compare the fund with an equal-weighted index to understand how much of its result came from a handful of names.
Watch out
Common mistakes.
- Assuming megacaps are safe because they are large, when even the biggest companies can lose a quarter of their value in a short time.
- Believing an index fund is automatically diversified, when a few megacaps may dominate its weighting.
- Treating the megacap label as fixed, when market capitalisation changes with every move in the share price.
Questions
People also ask.
What size makes a company a megacap?
There is no official figure, but a threshold of around $200,000,000,000 is commonly used. Some index providers use thresholds that differ from this, and the boundary moves over time as markets rise and fall.
Is a megacap the same as a large cap?
No, a megacap is a subset at the very top of the large-cap group. Large cap is the wider group, while megacap picks out only the biggest names, which can be a handful of companies in a given market.
Do megacaps always outperform?
No, their size can bring stability, but they can lag the market, and their past success does not guarantee future returns. Strong past performance does not guarantee future returns, and a very large company can lag the market for years.
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