Market capitalization is defined as the total dollar value of a stock’s out- standing shares and is computed by multiplying the number of outstanding shares by the current market price. Thus, market capitalization is a measure of corporate size. With approximately 8,500 stocks available to trade on U.S. stock exchanges, many traders judge a company by its size, which can be a determinant in price and risk. In fact, there are four unofficial size classifications for U.S. stocks: blue chips, mid-caps, small caps, and micro-caps.
1. Blue-chip stocks. Blue chip is a term derived from poker, where blue chips in a card game hold the most value. Hence, blue-chip stocks are those stocks that have the most market capitalization in the market- place (more than $5 billion). Typically they enjoy solid value and good security, with a record of continuous dividend payments and other desirable investment attributes.
2. Mid-cap stocks. Mid-caps usually have a bigger growth potential than blue-chip stocks but they are not as heavily capitalized ($500 million to $5 billion).
3. Small-cap stocks. Small caps can be potentially difficult to trade be- cause they do not have the benefit of high liquidity (valued at $150 million to $500 million). However, these stocks, although quite risky, are usually relatively inexpensive and big gains are possible.
4. Micro-cap stocks. Micro-caps, also known as penny stocks, are stocks priced at less than $2 per share with a market capitalization of less than $150 million.
Some traders like to trade riskier stocks because they have the potential for big price moves; others prefer the longer-term stability of blue-chip stocks. In general, deciding which stocks to trade depends on your time availability, stress threshold, and account size.
Posts Tagged ‘finance’
Market Capitalization
November 16th, 2010Incentives matter-choice is influenced in a predictable way by changes in incentives
July 4th, 2010This is probably the most important guidepost in economic thinking. It is sometimes called the basic postulate of all economics. As the personal benefits from an option increase, a person will be more likely to choose it. On the other hand, as the personal costs associated with an option increase, a person will be less likely to choose it. This guidepost also applies to groups of people, and suggests that making an option more beneficial will predictably cause more of them to choose it. Similarly, making an option more costly will cause fewer of them to choose it.
This basic idea is a powerful tool because its usefulness is practically universal. Incentives affect behavior in virtually all aspects of our lives, ranging from market decisions about what to buy to political choices concerning for whom to vote. If beef prices rise, making beef consumption more expensive relative to other goods, consumers will be less likely to buy it. The “incentives matter” postulate also explains why a person would be unlikely to vote for a political candidate who, if elected, would raise taxes to fund a new government program he or she didn’t like very much.
Most errors in economic reasoning occur because people overlook this postulate or fail to apply it consistently. With economic applications generally focusing on people trying to satisfy material desires, casual observers often argue that incentives matter only in cases of human selfishness. This view is false. People are motivated by a variety of goals, some humanitarian and some selfish, and incentives matter equally in both. Even an unselfish individual would be more likely to attempt to rescue a drowning child from a threefoot swimming pool than the rapid currents approaching Niagara Falls. Similarly, people are more likely to give a needy person their hand-me-downs rather than their favorite new clothes.
It is clear that incentives, whether monetary or nonmonetary, matter in human decision making. People will be less likely to walk down a dark alleyway than a well-lit one; they will be more likely to take a job if it has good benefits and working conditions than if it doesn’t; and they will be more likely to bend down and pick up a quarter lying on the sidewalk than they will a penny. Even a person who normally bends down to pick up pennies on the sidewalk probably would be less likely to if late for an important appointment, or on a first date.
Just how far can we push the idea that incentives matter? If asked what would happen to the number of funerals performed in your town if the price of funerals rose, how would you respond? The “incentives matter” postulate predicts that the higher cost would reduce the number of funerals. While the same number of people will still die each year, the number of funerals performed will still fall as more people choose to be cremated or buried in cemeteries in other towns. Substitutes are everywhere-even substitutes for funerals.
The test of a theory is its ability to predict
July 9th, 2009Economic thinking is scientific. The proof of the pudding is in the eating. How useful an economic theory is depends on how well it predicts the future consequences of economic action. Economists world. Good theories are con- develop economic theories using scientific thinking based on basic principles. The idea is consistent with and help explain real-world events. Theories that are inconsistent with the to predict how incentives will affect decision makers and compare the predictions against real-world events. If the events in the real world are consistent with a theory, we say that real world are invalid and must be rejected. the theory has predictive value and is therefore valid. If it is impossible to test the theoretical relationships of a discipline, the discipline does not qualify as a science. Because economics deals with human beings who can think and respond in a variety of ways, can economic theories really be tested? The answer to this question is yes, if, on average, human beings respond in predictable and consistent ways to changes in economic conditions. The economist believes that this is the case, even though not all individuals will respond in the specified manner. Economists usually do not try to predict the behavior of a specific individual; instead, they focus on the general behavior of a large number of individuals.
In the 1950s, economists began to do laboratory experiments to test economic theories. Individuals were brought into laboratories to see how they would act in buying and selling situations, under differing rules. For example, cash rewards were given to individuals who, when an auction was conducted, were able to sell at high prices and buy at low prices, thus approximating real-world market incentives. These experiments have verified many of the important propositions of economic theory.
Laboratory experiments, however, cannot duplicate all real economic interactions. How can we test economic theory when controlled experiments are not feasible? This is a problem, but economics is no different from astronomy in this respect. Astronomers can use theories tested in physics laboratories, but they must also deal with the world as it is. They cannot change the course of the stars or planets to see what impact the change would have on the gravitational pull of Earth. Similarly, economists cannot arbitrarily change the prices of cars or unskilled-labor services in real markets just to observe the effects on quantities purchased or levels of employment. However, economic conditions (for example, prices, production costs, technology, and transportation costs), like the location of the planets, do change from time to time. As actual conditions change, an economic theory can be tested by comparing its predictions with real-world outcomes. Just as the universe is the main laboratory of the astronomer, the real-world economy is the primary laboratory of the economist.
Beware of the secondary effects: Economic actions often generate indirect as well as direct effects
July 7th, 2009In addition to direct effects that are quickly visible, people’s decisions often generate indirect, or “secondary,” effects that may be observable only with time. Failure to consider secondary effects is one of the most common economic errors because these effects are often quite different from initial, or direct, effects. Frederic Bastiat, a nineteenth-century French economist, stated that the difference between a good and a bad economist is that the bad economist considers only the immediate, visible effects.
The true cause of these secondary effects might not be seen, even later, except by those using the logic of good economics.
Perhaps a few simple examples that involve both immediate (direct) and secondary (indirect) effects will help illustrate the point. The immediate effect of an aspirin is a bitter taste in one’s mouth. The secondary effect, which is not immediately observable, is relief from a headache. The short-term direct effect of drinking twelve cans of beer might be a warm, jolly feeling. In contrast, the secondary effect is likely to be a sluggish feeling the next morning, and perhaps a pounding headache.
Sometimes, as in the case of the aspirin, the secondary effect-headache relief-is actually an intended consequence of the action. In other cases, however, the secondary effects are unintended. Changes in government policy often alter incentives, indirectly affecting how much people work, earn, invest, consume, and conserve for the future. When a change alters incentives, unintended consequences that are quite different from the intended consequences may occur.
Let’s consider a couple of examples that illustrate the potential importance of unin- tended side effects. In an effort to reduce gasoline consumption, the federal government mandates that automobiles be more fuel efficient. Is this regulation a sound policy? It may be, but when evaluating the policy’s overall impact, one should not overlook its secondary effects. To achieve the higher fuel efficiency, auto manufacturers will reduce the size and weight of vehicles. As a result, there will be more highway deaths-about 2,000 more per year-than would otherwise occur because these lighter cars do not offer as much protec- tion for occupants. Furthermore, because the higher mileage standards for cars and light trucks make driving cheaper, people tend to drive more than they otherwise would. Thi increases congestion and results in a smaller reduction in gasoline consumption than was intended by the regulation. Once you consider the secondary effects, the fuel efficiency regulations are much less beneficial than they might first appear.
Trade restrictions between nations have important secondary effects as well. The proponents of tariffs and quotas on foreign goods almost always ignore the secondary effects of their policies. Import quotas restricting the sale of foreign-produced sugar in the U.S. market, for example, have led to sugar prices that are about three times what they are in the rest of the world. The proponents of this policy-primarily sugar producers-argue that the quotas “save jobs” and increase employment. No doubt, the employment of sugar growers in the United States is higher than it otherwise would be. But what about the secondary effects? The higher sugar prices mean it’s more expensive for U.S. firms to produce candy and other products that use a lot of sugar. As a result, many candy producers, including the makers of Life Savers, Jaw Breakers, Red Hots, and Fannie May and Fanny Farmer chocolates, have moved to countries like Canada and Mexico, where sugar can be purchased at its true market price. Thus, employment among sugar-using firms in the United States is reduced. Further, because foreigners sell less sugar in the United States, they have less purchasing power with which to buy products we export to them. This, too, reduces U.S. employment. Once the secondary effects of trade restrictions like the sugar quota program are taken into consideration, we have no reason to expect that U.S. employment will increase as a result. There may be more jobs in favored industries, but there will be less employment in others. Trade restrictions reshuffle employment rather than increase it. But those who unwittingly fail to consider the secondary effects will miss this point. Clearly, consideration of the secondary effects is an important ingredient of the economic way of thinking.
Individuals make decisions at the margin
July 5th, 2009When making a choice between two alternatives, individuals generally focus on the difference in the costs and benefits between alternatives. Economists describe this process as marginal decision making, or “thinking at the margin.” The last time you went to eat fast food, you probably faced a decision that highlights this type of thinking. Will you get the $1.50 cheeseburger and the $1.00 medium drink, or instead get the $3.00 value meal that has the cheeseburger and drink and also comes with a medium order of fries? Naturally, individual decision making focuses on the difference between the alternatives. The value meal costs 50 cents more (its marginal cost) but will give you one extra food item-the fries (its marginal benefit). Your marginal decision is whether it is worth the extra 50 cents to have the fries. If you pay attention, you’ll notice yourself frequently thinking at the margin. Next time you find yourself asking a salesclerk “How much more is this one?” when you are choosing between two items, you are doing a marginal analysis.
Marginal choices always involve the effects of net additions to or subtractions from current conditions. In fact, the word additional is often used as a substitute for marginal. For example, a business decision maker might ask, “What is the marginal cost of producing one more, or additional, unit?’ Marginal decisions may involve large or small changes. involves additional costs and additional benefits. Given the current situation, what marginal benefits (additional sales revenues, for example) can be expected from the new factory, and what will be the marginal cost of constructing it? What is the marginal benefit versus marginal cost of purchasing a new stapler? The answers to these questions will determine whether building the new factory or buying the new stapler is a good decision.
It is important to distinguish between average and marginal. A manufacturer’s average cost of producing automobiles (which would be the total cost of production divided by the total number of cars the manufacturer produces) may be $25,000, but the marginal cost of producing an additional automobile (or an additional 1,000 automobiles) might be much lower, say, $10,000 per car. Costs associated with research, testing, design, molds, heavy equipment, and similar factors of production must be incurred whether the manufacturer is going to produce 1,000 units, 10,000 units, or 100,000 units. Such costs will clearly contribute to the average cost of an automobile, but they will change very little as additional units are produced. Thus, the marginal cost of additional units may be substantially less than the average cost. Should production be expanded or reduced? That choice should be based on marginal costs, which indicate the change in total cost due to the decision.
Confusion between marginal and total benefits or costs can also be a source of error. Almost all of the choices we make are marginal, rather than all-or-nothing decisions. For example. we don’t make decisions between eating or wearing clothes-dining well in the nude versus starving in style. Instead, we choose between having a little more food at the cost of a little less clothing, or a little less of something else. So the relevant comparison is not betkween the total value of food and the total value of clothing but between their marginal values.
People commonly ignore the implications of marginal thinking in their comments, but seldom in their actions. Thus, the concept is far better at explaining how people act than what they say. Students are often overheard telling other students that they shouldn’t skjp class because they have paid to enroll in it. Of course, the tuition is not a factor relevant at I The “one more unit” could be a new factory or a new stapler. It is marginal because it in-the margin-it will be the same whether or not the student attends class on that particular day. The only real marginal considerations are what the student will miss that day (a quiz, information for the exam, etc.) versus what he or she could do with the extra time by skipping class. This explains why even students who tell others they paid too much for the class to skip it will ignore the tuition costs when they themselves decide to skip class. When we confront a decision, the marginal benefit and marginal cost associated with the choice will determine our decision. Marginal analysis will be used extensively throughout this course. As we develop this concept further, you should pay special attention to understanding how to use it properly.