Market cap or Market capitalization is the total value of a company’s shares of stock. If a company has issued 1 million shares, and its share price is $1000, its market cap is $1 billion.
Market cap is calculated by multiplying the number of stock shares outstanding by the current share price. Shares outstanding include all shares — those available to the public as well as restricted shares available to and held by specific groups.
Key Points:
Market capitalization refers to how much a company is worth as determined by the stock market. It is defined as the total market value of all outstanding shares.
To calculate a company’s market cap, multiply the number of outstanding shares by the current market value of one share.
The market cap allows investors to evaluate a company based on how valuable the public perceives it to be.
Companies are typically divided according to market capitalization: large-cap ($10 billion or more), mid-cap ($2 billion to $10 billion), and small-cap ($300 million to $2 billion).
Market cap is often used to determine a company’s size, then evaluate the company’s financial performance to other companies of various sizes.
In investing, companies with larger market capitalization are often safer investments as they represent more established companies with a generally longer history in the business.
Investing across market caps can help create a diversified portfolio.
How to Calculate Market Capitalization
The market capitalization formula is:
Market Cap = Current Share Price * Total Number of Shares Outstanding
For example, a company with 20 million shares selling at $100 a share would have a market cap of $2 billion. A second company with a share price of $1,000 but only 10,000 shares outstanding, on the other hand, would only have a market cap of $10 million.
A company’s market cap is first established via an initial public offering (IPO). Before an IPO, the company that wishes to go public enlists an investment bank to employ valuation techniques to derive a company’s value and to determine how many shares will be offered to the public and at what price.
Market Capitalization Importance
It allows investors to understand the relative size of one company versus another. Market cap measures what a company is worth on the open market, as well as the market’s perception of its future prospects because it reflects what investors are willing to pay for its stock.
Large-cap companies are typically firms with a market value of $10 billion or more. Large-cap firms often have a reputation for producing quality goods and services, a history of consistent dividend payments, and steady growth.
They are often dominant players within established industries, and their brand names may be familiar to a national consumer audience.
As a result, investments in large-cap stocks may be considered more conservative than investments in small-cap or mid-cap stocks, potentially posing less risk in exchange for less aggressive growth potential.
Mid-cap companies are typically businesses with a market value between $2 billion and $10 billion. Typically, these are established companies in industries experiencing or expected to experience rapid growth.
These medium-sized companies may be in the process of increasing market share and improving overall competitiveness. This stage of growth is likely to determine whether a company eventually lives up to its full potential.
Mid-cap stocks generally fall between large caps and small caps on the risk/return spectrum. Mid-caps may offer more growth potential than large caps, and possibly less risk than small caps.
Small-cap companies are typically those with a market value of $300 million to $2 billion. Generally, these are young companies that serve niche markets or emerging industries.
Small caps are considered the most aggressive and risky of the 3 categories. The relatively limited resources of small companies can potentially make them more susceptible to a business or economic downturn.
They may also be vulnerable to the intense competition and uncertainties characteristic of untried, burgeoning markets.
On the other hand, small-cap stocks may offer significant growth potential to long-term investors who can tolerate volatile stock price swings in the short term.
Misconceptions About Market Caps
Although it is used often to describe a company, the market cap does not measure the equity value of a company.
Only a thorough analysis of a company’s fundamentals can do that. It is inadequate to value a company because the market price on which it is based does not necessarily reflect how much a piece of the business is worth. Shares are often over- or undervalued by the market, meaning the market price determines only how much the market is willing to pay for its shares.
Although it measures the cost of buying all of a company’s shares, the market cap does not determine the amount the company would cost to acquire in a merger transaction. A better method of calculating the price of acquiring a business outright is the enterprise value.
Conclusion
Market cap can be a valuable tool for an investor who is watching stocks and evaluating potential investments.
Market capitalization is a quick and easy method for estimating a company’s value by extrapolating what the market thinks it is worth for publicly traded companies.
The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.
In an acquisition, the market cap is used to determine whether a takeover candidate represents a good value or not to the acquirer.
