Why Market Capitalization is Important
Market capitalization (market cap) is the market value of the outstanding shares of a publicly traded company at a point in time. It is equal to the share price at that time multiplied by the number of outstanding shares. As the outstanding stock is bought and sold in public markets, capitalization could be used as an indicator of public opinion of a company’s net worth and is a crucial factor in stock valuation.
Investors use market capitalization in ranking the size of companies. It is used in ranking the relative size of stock exchanges and the sum of the market capitalization of all companies are listed on each stock exchange for an easy reference.
Market capitalization is based on a company’s current share price and a total number of outstanding stocks. It’s calculated by multiplying the current market price of the share with the total outstanding shares.
If a company has 20 million outstanding shares and its current market price per each share is Rs100 the market capitalization of the company is 200,00,000 x 100 = Rs 200 crores.
Company stocks come in three types. Stocks with a market cap of Rs 10,000 crore or more are large cap stocks. Company stocks using a market cap of 10 crores and Rs 2 crore are mid-cap stocks. Those less than Rs 2 crore market cap are small cap stocks.
Market Capitalization Ranking
Companies can be ranked according to their market capitalization. The general format is to rank them as large-cap, mid-cap, and small-cap companies. There may be some differences depending on the market where the company trades and is ranked, although there are basic criteria for putting companies in these categories.
Large-cap companies have a market capitalization of $10 billion or more. These large companies have been in existence for a long time, and they are major players in well-established industries. Investing in large-cap companies doesn’t bring in huge returns in a short period of time, but over the long run, these companies generally reward investors with a consistent increase in dividend payments and share value. An example of a large-cap company is International Business Machines Corp.
Mid-cap companies have a market capitalization of between $2 billion and $10 billion. Mid-cap companies are established companies. Mid-cap companies are in the process of expanding. They carry a higher risk than large-cap companies because they’re not established, but they’re attractive for their growth potential. An example of a mid-cap company is Eagle Materials Inc.
Companies that have a market capitalization of between $300 million to $2 billion are generally classified as small-cap companies. HMS Holdings Corp. is an example of a small-cap company. These small companies could be young in age and/or they could serve new industries and niche markets. These companies are considered higher risk investments because of their age, size, and the markets they serve. Smaller companies with fewer resources are more sensitive to economic slowdowns.
Market Capitalization Calculation
As mentioned previously, market capitalization is calculated by multiplying the company’s outstanding shares by its own stock price per share. The price of the stock can change from minute to minute, although the number of outstanding shares is reported on a quarterly basis. The value of market capitalization is as fluid as the market price. For instance, a company with 10 billion outstanding shares trading at a price of $10 per share has a market capitalization of $100 billion. A company with 100 billion shares outstanding and trading at a price of $ 1 has a market capitalization of $100 billion.
Market Capitalization Categories
In general, stocks are lumped into three categories of capitalization: large cap, mid cap, and small cap. A large-cap company has a market capitalization over $10 billion. A mid-cap company has a market capitalization between $2 billion and $10 billion, and a small-cap company has less than $2 billion in market capitalization. Generally, small caps have less access to the capital markets’ lower trading liquidity and not as much experience, and there is less information available about small caps than large caps.
Due to their size, large-cap stocks are believed to be safer. However, they might not offer the same opportunities for growth as small-cap and mid-cap stocks. Financial advisors suggest diversifying an investment portfolio by including small-cap, mid-cap, and large-cap stocks for investors with long-term investment horizons.
Why it Matters:
Market capitalization reflects the theoretical cost of buying all of the shares of a company but it might not be the actual value of a company in a merger transaction. To estimate what it’d cost for an investor to buy a company, the enterprise value calculation is more appropriate.
Market capitalization is a better measure of size than worth. Thus, market capitalization isn’t the same as market value, which can generally be assigned when the company is sold.
The Per-Share Price Fallacy
Is a stock that costs $50 valued less than another stock that costs $10? The per-share price of a stock is thought to convey some sense of value relative to other stocks.
The per-share price is not important. It always changes and since the outstanding shares of each company differ, it does not provide enough information to give an estimate of a company’s value.