What is Market Capitalization and How to Calculate It?

Learn about market capitalization and how to calculate it. Explore its pros and cons and why it is important when making investment decisions.

Understanding the relationship between company size, its return potential, and associated risks are vital if you wish to create an investment strategy to pursue long-term financial goals. This knowledge will prepare you to build a balanced stock portfolio with a mix of market capitalization or “market caps.”

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Content

• What is Market Capitalization?
• How Is Market Cap Calculated?
• Categories Of Companies According To Market Cap
• Advantages of Choosing Stocks Based on Market Caps
• Disadvantages Of Choosing Stocks Based On Market Caps
• Why Should You Care About Market Caps?

What is Market Capitalization?

Market cap or capitalization is an economic measure that indicates the capital value of a company obtained from its listing on the stock market. This concept is fundamental because investors use this number to determine the size of a company in its market context rather than using sales or total asset numbers. 

In other words, it is what that company’s outstanding shares are worth. That is, what a listed company is worth. 

Suppose a company has a market capitalization of 10,000 million euros. In that case, it has a value of 10,000 million euros and, therefore, if we wanted to buy 100% of the firm, we would have to buy back all the shares valued at 10,000 million.

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How Is Market Cap Calculated?

Market Cap is calculated by multiplying the number of shares that a company has outstanding by the unit price of the current market price. The resulting figure is the price for which we could purchase all of those securities, with all their assets, if we had enough money to pay them off. Therefore, market capitalization is not a fixed value that is maintained over time but changes as much as the prices of its shares.

Theoretically, the calculation of the market capitalization is simple and is based on the following formula:

Market Cap = Current share price x number of shares

An example: If a company is currently trading on the market at $78 and the number of shares outstanding is equal to 10 million shares, then the market capitalization of this company is $780 ($78×10) million.

Categories Of Companies According To Market Cap

Market capitalization is an excellent indicator of the size of a company, something not to be confused with the actual value of the company. Some market capitalization categories include:

• Large-Cap: Companies with a market capitalization of more than $10 billion

Examples – ITC Ltd., Hindustan Unilever Ltd., Reliance Industries Ltd., Larsen & Toubro, Microsoft, General Electric, etc.

• Mid-Cap: Companies with a market capitalization between $2-10 billion.

Examples – Crompton Greaves, Relaxo Footwears, Polycab India, Coforge, Bharat Electronics, Exide Industries, Bharat Forge, Tripadvisor, Western Union, etc.

• Small-Cap: Companies with a market capitalization between 300 million and 2 trillion US dollars. Examples – Nippon India, NESCO Ltd. Services, Thyrocare Technologies Ltd., Delta Corp Ltd., Jackson Financial Inc., JK Paper Ltd., etc.

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In general, smaller companies are riskier than larger ones, but in some cases, they can also have much higher growth potential.

Although small, medium and large are the more traditional categories, tags have also been created for the extremes :

Micro-Cap = $50 – $300 million

Mega-Cap = Over $300 billion.

Market cap fluctuates in each market session, either up or down, at the rate that the price of each share rises and falls. However, the larger a company is, the more stable the level of capitalization is generally, and it has less volatility due to its larger size. 

Similarly, a company with a smaller cap generally has higher volatility because it is smaller. The reason is that the larger a company is, the more shareholders it will have and, therefore, the less risk of sharp falls. However, a smaller company is in fewer hands, meaning the price is more volatile and more manipulable. The size of publicly traded companies is divided by market capitalization into small caps.

Advantages of Choosing Stocks Based on Market Caps

Market capitalization is often used in making decisions about stocks to invest in, as it provides investors with information about the relative size of one company compared to another. For this reason, investors tend to divide stocks into categories based on their market capitalization: large-cap, mid-cap, and small-cap.

Large-cap companies typically have a market capitalization of $10 billion, mid-caps $2-10 billion, and small-caps $300-2 billion. The limit values ​​of each category can be diffuse and differ from country to country.

Market capitalization is a simple and relatively effective way to assess risk. Investing in large-cap companies provides long-term rewards and less risk as the companies are well established. Mid-cap companies have excellent growth potential but tend to be riskier than large-cap stocks (although not as risky as small-caps). Small-cap companies are often considered a high-risk investment option due to, for example, their limited financial resources.

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Disadvantages of Choosing Stocks Based on Market Caps

Despite the benefits, there are also some limitations to this method. For example, the value of a business (its enterprise value) is not accurately reflected in the market capitalization but only reflects the value of the shares. Stock prices can be overvalued or undervalued because they only reflect how much the market is willing to pay.

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Why Should You Care About Market Capitalization?

Market cap measures a company’s value on the open market and the market’s perception of its prospects. Thus, the market cap is a simple but effective measure of a particular company or industry’s value. It charts a company’s current growth trajectory and helps predict its future. Market cap is a measure that can help you make sound investment decisions. However, when weighing the risks of an investment, you must also consider market trends, stability, and your financial situation.

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