What is Equity Market Capitalization
Equity market capitalization measures the total market value of an equity market. The measure is calculated by taking the market capitalization of all companies in the equity market and adding them together to arrive at the capitalization for the market as a whole.
BREAKING DOWN Equity Market Capitalization
Equity market capitalization is used to compare the increase or decrease in the size of the market as a whole. The measure is also used to compare the value of the equity market to other segments of the economy, such as the value of the real estate market.
Market capitalization refers to the total dollar market value of a company's outstanding shares. Commonly referred to as "market cap," it is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size.
Using market capitalization as a basis for determining the size of a company, and a market as a whole, is important because company size is a basic determinant of various characteristics in which investors are interested, including risk. It is also easy to calculate. For example, a company with 20 million shares selling at $100 per share would have a market cap of $2 billion.
Limitations of Equity Market Capitalization
Although it is used often to describe the size company, 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 overvalued 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.
Two primary factors can alter company's market cap: significant changes in the price of a stock or when a company issues or repurchases shares. An investor who exercises a large number of warrants can also increase the amount of shares on the market and negatively affect shareholders in a process known as dilution. Because of these factors, equity market capitalization, which is a composite sum of all the market caps of all equities in a market, is not a good measure for ascertaining the value of an equity market...only the size.