What is Market Capitalization?
Market capitalization, often abbreviated as “market cap,” represents the total market value of a company’s outstanding shares of stock. Investors use this calculation to determine a company’s size as opposed to metrics like sales or total asset value. In the realm of acquisitions, assessing market cap helps identify if a company represents a worthwhile investment for prospective buyers.
Key Takeaways
- Market capitalization evaluates a company’s worth based on the total market value of all its outstanding shares.
- It is calculated by multiplying the number of outstanding shares by the current market value of one share.
- Investors use market cap to evaluate and compare the financial performance of companies relative to their sizes.
How to Calculate Market Cap
In straightforward terms, market capitalization is the result of the market’s valuation of a publicly-traded company, obtained by multiplying the share price by the total number of outstanding shares. Here is the basic formula: Market Cap = Current Share Price * Total Number of Shares Outstanding
For example, if a company has 20 million shares each priced at $100, its market cap is $2 billion. Conversely, a company with shares priced at $1,000 but only 10,000 shares outstanding would have a market cap of $10 million.
An initial public offering (IPO) determines a company’s inaugural market cap, as investment banks use valuation techniques to decide the number and price of shares released to the public.
Market Cap and Company Size
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Large-cap Companies: Typically, these companies have market capitalizations exceeding $10 billion. Representing well-established industry leaders, large caps often provide consistent growth in share value and dividends. Notable examples include Apple Inc. and Microsoft Corp.
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Mid-cap Companies: These firms usually have a market cap ranging between $2 billion and $10 billion. Such companies might be experiencing significant growth within their respective industries but carry marginally higher risk compared to large-caps.
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Small-cap and Micro-cap Companies: Companies with market caps between $250 million and $2 billion are considered small caps. These firms often provide higher growth potential, although they also pose higher risks. Companies with a market cap below $250 million are typically micro-caps.
Market Cap in the Digital Currency Domain
For digital currencies, a different formula assesses market cap to incorporate the potential dilution effect of all authorized shares or tokens. The diluted market cap formula is: Diluted Market Cap = Current Share Price * Total Number of Shares Authorized
For example, if Bitcoin trades at $24,000 per coin, with 19.1 million Bitcoins issued and a potential of 21 million existing, the calculations would be:
Market Cap: $24,000 * 19.1 million = $458.4 billion
Diluted Market Cap: $24,000 * 21 million = $504 billion
Common Misconceptions About Market Caps
While market cap does describe a company’s market valuation, it does not measure the true equity value of a company. Only a comprehensive analysis of a company’s fundamentals can achieve this. Market cap only reflects what the market is willing to pay for a company’s shares, without accounting for overvaluation or undervaluation scenarios.
Moreover, it does not consider the cost to completely acquire a company in a merger; the enterprise value provides a better acquisition cost.
Factors Influencing Market Cap
Significant changes in stock price or the issuance/repurchase of shares can impact a company’s market capitalization. Additionally, an increase in the number of shares available due to investors exercising warrants can lead to dilution, affecting the existing shareholders.
Significance of a High Market Cap
A high market cap implies that a company has a substantial market presence. While these firms might exhibit lower growth rates compared to startups, they benefit from easier access to financing, stable revenue streams, and strong brand recognition.
Does Market Cap Affect Stock Price?
Market cap does not influence stock price directly. Instead, it is derived from the analysis of stock price and the number of issued shares. While high market cap companies might perform better, it does not directly affect their stock prices.
Why is Market Cap Important?
Market cap is a fundamental metric for analyzing company performance. It sets the context for reviewing other financial parameters, enabling meaningful evaluations of relative revenue performances within the industry. Thus, it helps identify whether a company is under- or overperforming relative to its market cap.
The Bottom Line
Market capitalization is a crucial metric for investors interested in evaluating and tracking stocks. It offers an expedited approach to estimating a company’s value through public perception for publicly traded entities. In acquisition contexts, market cap plays an essential role in assessing the attractiveness of takeover candidates.
Related Terms: Equity, Shares, IPO, Trading, Stocks, Dilution.
References
- FINRA. “Market Cap Explained”.
- Coindesk. “Bitcoin”.
- Nasdaq. “Eagle Materials Inc Common Stock”.
- Coinbase. “Tokenomics 101”.
