Market capitalization is a useful figure to examine when trying to understand a company's structure and profitability, and therefore a stock's value. It can be used to determine a variety of key performance metrics, including price-to-earnings and price-to-free-cash flow.
Market capitalization refers to the total dollar market value of a company's outstanding shares. Colloquially called "market cap," it is calculated by multiplying the total number of a company's shares by the current market price of one share. The investment community uses this figure to determine a company's size, and basically how the stock market is valuing the company.
- Market capitalization is the total dollar value of all of a company's outstanding shares.
- It's determined by multiplying the company's stock price by its total number of outstanding shares.
- Investors can use market capitalization to assess the value of a stock they are considering buying.
- Market capitalization is a key measure of profitability that is also used in equations to determine price-to-earnings and other significant metrics.
- Market cap is generally broken down as micro cap, small cap, mid cap, large cap and ultra or mega cap.
Performance Metrics That Use Market Cap
There are a number of popular valuation ratios that include market capitalization that investors should look at when considering buying a stock. These ratios include:
- Price-to-earnings ratio: calculated by dividing market cap by 12-month net income; can reference trailing earnings or projected future earnings
- Price-to-free-cash-flow ratio: calculated by dividing market cap by 12-month free cash flow (derived by subtracting capital expenses from cash flow from operations; can also use historical or projected returns
- Price-to-book value: calculated by dividing market cap by total shareholder equity (the balance of total assets and liabilities).
- Enterprise-value-to-EBITDA (earnings before interest, taxes, depreciation and amortization): functions similarly to the price to earnings ratio; enterprise value is calculated by totaling the market value of common and preferred equity, minority interest and net debt. EBITDA measures operational returns in the short term.
Generally, large-cap stocks are slower growth and therefore more likely to pay dividends than faster growing, small- or mid-cap stocks.
Market Cap Types
There is no official barrier for different categories of stocks based on size, but large caps are often companies with market caps over $10 billion, while mid caps are $2 billion to $10 billion, and small caps are under $2 billion. There are further categories that investors will sometimes consider, such as micro caps, referring to small-cap stocks that are under $250 million, and ultra or mega cap stocks, which are large caps that are over $50 billion.
Market capitalization is used to set investor expectations and shape investment strategy. Different types of investment strategies focus on the various market cap groups, and different valuation methods are applied depending on company size. Very large market caps are usually associated with mature, low-growth companies that pay dividends. Small caps are often growth companies with higher-risk profiles and generally do not pay dividends.