What is Market Capitalization
Market capitalization refers to the total dollar market value of a company's outstanding shares of stock. Commonly referred to as "market cap," it is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share. As an example, a company with 10 million shares selling for $100 each would have a market cap of $1 billion. The investment community uses this figure to determine a company's size, as opposed to using sales or total asset figures.
Using market capitalization to show the size of a company 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. A company with 20 million shares selling at $100 a share would have a market cap of $2 billion.
Understanding Market Capitalization
Given its simplicity and effectiveness for risk assessment, market cap can be a helpful metric in determining which stocks you are interested in, and how to diversify your portfolio with companies of different sizes.
- 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.
- 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).
Large-cap companies typically have a market capitalization of $10 billion or more. These large companies have usually been around for a long time, and they are major players in well-established industries. Investing in large-cap companies does not necessarily 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 share value and dividend payments. An example of a large-cap company is International Business Machines Corp.
Mid-cap companies generally have a market capitalization of between $2 billion and $10 billion. Mid-cap companies are established companies that operate in an industry expected to experience rapid growth. Mid-cap companies are in the process of expanding. They carry inherently higher risk than large-cap companies because they are not as established, but they are 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. These small companies could be young in age and/or they could serve niche markets and new industries. These companies are considered higher risk investments due to their age, the markets they serve, and their size. Smaller companies with fewer resources are more sensitive to economic slowdowns.
In order to make an investment decision, you may need to factor in the market cap of some investments. For more information on market capitalization, read Understanding Small- And Big-Cap Stocks.
Misconceptions About Market Caps
Although it is used often to describe a 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 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.
Changes in Market Cap
Two main 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. (For related reading, see "Understanding Market Capitalization Versus Market Value")