What is Market Capitalization?
Updated on 24 Feb 2020
Market Cap or Market Capitalization refers to the total dollar value of a company’s outstanding shares. It has a direct impact on the market value of a brand, and an investor’s choice to invest in it.
What is Market Cap?
A market cap or market capitalization is the total market value of a company in dollars. To calculate it, the Current Market Price (CMP) of its shares and the outstanding shares are used. In simpler terms, it tells you about the size of the company and what would the amount of money that one has to spend in order to buy a company.
Of course, we are talking about publicly listed companies here and not a private firm, as they have a separate set of rules for evaluation. Based on the market cap, the companies can be put into various categories, like mega-cap, small-cap and micro-cap and so on.
How to calculate the market cap of a company?
There is a simple mathematical formula to calculate the market cap of a company.
Market cap of a company = Current market price (per share) x total number of shares
The logic behind this formula is simple as a company is represented by the number of shares available in the market and multiplying it with the per share price will give you the market cap or market value of the company. For example, if a company has a million shares with each share being sold at $20, the market cap of the company will amount to $20 million.
However, one thing you need to understand is that the market cap of a company does not tell you about the market share it has in that particular industry. Moreover, the value of a single share does not tell you about the total market value of the company. A company like Microsoft sells its shares at $101.16 and had a market value of $814 billion during October 2018, whereas IBM sold its shares at $142.69 but had a market value of just $130 billion during the same time last year.
Different categories of market-cap
The highest valued companies come in this category with the minimum qualification bar set at $200 billion in this category. The companies that come in this category are the biggest in their industries. Apple, Microsoft, Amazon, and Facebook are some of the top examples of mega-cap companies.
Large-cap companies are the ones that fall between the market cap of $10 billion and $200 billion. IBM and GE are the prime examples of this category.
The mega-cap and large-cap companies are safest to invest in because of the stability it enjoys. However, that does not mean the stability is permanent.
Mid-cap companies fall under the bracket of $2 billion-$10billion market cap. These are the companies that may not be the leading in their industries but surely is on its way up there.
Companies with market cap between $300 million to $2 billion fall under the small-cap companies. It involves the budding new companies and also a few old companies that have seen a drop in market cap over the years.
The category of Micro-cap has companies that are evaluated between $50 million and $300 million. They usually have penny stocks and are not that reliable when it comes to market trends. The risk appetite is quite big for investors in this category.
Companies in Nano-cap trade in pink sheets and have market caps less than $50 million. The stocks of such companies are the most volatile and hence the riskiest of the lot.
The importance of market caps and how it has an effect across industries
One important thing that you first need to understand is that the value of a share is not the right estimate for the market value of the company itself. In many ways, a market cap is everything for a company. It determines a lot of decisions related to the functioning of a company and has the power to impact the whole industry itself.
The biggest example of this impact can be seen with the risk appetite of the huge companies that fall under the mega-cap category. A company like Amazon or Microsoft can easily venture into other industries by investing a few hundred dollars and not really taking a huge hit even if they fail. However, this is not the case with companies that are small-cap or less as they do not have the luxury to spend wildly.
As a direct result of this practice by big companies, the evaluation of small-cap companies take a hit. A recent example of this is when Amazon entered the web hosting services with AWS, it had a huge impact in this niche industry where the smaller companies were thriving. However, when a small company does venture into a bigger project and succeed, the growth in their market value is much more than an already established company but the risk here is obviously a lot more.
The same can be said for when you invest. Yes, investing in bigger companies will be less risky but investing in smaller companies can give you higher returns. However, you do need to factor in the fact that the smaller companies have less resources and too much competition. The bottom line is that it is your appetite for risk that will help you make the right decision.
To get more info on how market cap impacts an industry and how external factors can impact the market cap of a company, get in touch Kristal.
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