The definition of a stock market cap is the total dollar market value of the outstanding shares of company stock. The market capitalization formula is simple. You multiply the number of total outstanding shares of stock on the market by the current price of one share of stock. For example, a company with 20 million shares, valued at $50 each, would have a market cap of $1 billion. Investment companies will use these factors to determine the size of a company instead of the total sales of asset figures.
Determining market capitalization is crucial for investors as it not only indicates the size of the company but the risk, as well. In this guide, you will learn:
- What constitutes a large cap company?
- What are mid cap companies?
- What types of companies would be considered small cap?
- What size caps make the best investments?
- What are some of the common misconceptions about market cap?
- What can affect changes in market cap?
- How can market capitalization affect the value of the stock?
- The difference between market value and market capitalization.
- The difference between stock price and market value.
- The difference between the free-float cap and market cap.
- What is the capitalization ratio?
- How traders can use market capitalization.
What Are Large Cap Companies?
Large cap (or big cap) companies will have a value estimated at $10 billion or more. These are the major players in the industry and are well-established. Even though these companies are relatively stable and don’t carry great investment risk, they don’t always bring large returns in a short period. These investments are best for long term investors as the company will typically reward their investors with regular dividend payments and increased share value over time. These companies will have steady growth and are typically well-known brands.
What Are Mid Cap Companies?
Mid cap companies will have a value somewhere between $2 billion and $10 billion. These companies are also well established and operate in industries that will expect to see an increase in growth. They are often considered higher risk than large cap companies, but their potential for growth can make them attractive to investors.
What Are Small Cap Companies?
Companies with capitalization between $300 million and $2 billion are referred to as small cap businesses. They are often young companies or companies that serve newer or niche industries. These are considered risky investments as they will be more susceptible to economic downturns and have fewer assets and resources.
What Size Cap Is Best to Invest In?
Since each size market cap comes with various risk levels, having a proper mix can provide you with a better portfolio. You will need to evaluate your time frame, your risk tolerance, and your end financial goals to create the ideal mix that will help grow your wealth in the manner you need it to. By keeping your portfolio diversified, you will reduce your overall risk and have a better chance of meeting your long-term financial goals.
What Are Some Misconceptions About Market Cap?
Many people are under the misconception that a stock’s market cap is an accurate measure of the equity value of the company. Since shares can be over or undervalued, as the market price is what determines the value of the shares, the only way to determine the true equity value of a company is by performing an analysis of the company’s fundamentals.
What Can Affect Changes in Market Cap?
There are two primary factors that can influence a company’s market cap. There can be major changes to the market cap when a company either issues or repurposes shares. Or dilution, where an investor exercises a large number of warrants, can increase the number of shares and negatively affect the other shareholders.
While stock splits don’t necessarily affect the market cap when it occurs, with the price reduced and the number of shares increased, it can increase a trading demand which can put the stock on an upward trend in the future.
How Can Market Capitalization Affect the Value of the Stock?
Calculating market capitalization can give you a good indication of the value of a stock when used with other indicators. But since supply and demand rule stock prices, the cost can drastically shift based on what investors are willing to pay, more than what the company will actually be worth.
Market Value vs. Market Capitalization
Determining the value of a company is extremely important to investors when they are trying to determine the overall value of their investment. You can use both the market value and the market cap to determine the value of a company and decide whether or not the investment is a good one. Since both the terms are similar and refer to a company’s overall value, many people fail to distinguish them.
Market cap is a metric that is based on the current price of the stock as it is trading today. The market value goes well beyond a market cap calculation. It takes a broader view of the strength and stability of a company as well as its overall size.
Stock Price v. Market Value
A stock price does not tell you everything you need to know about the value of a company, especially when it comes to deciding whether the investment is likely to produce the returns you need. While the price per share of stock can be an indicator of the value of a company, it needs to be combined with other metrics and information to come up with a true company value. The price-per-share will fluctuate with the market climate and can even fluctuate seasonally. The number of shares can also shift, which can significantly change the price-per-share.
This is where market capitalization comes into play. It is a metric that can be used to help bridge the gap between the price of the stock and the overall value of the company because it not only takes into account the cost per share but also how many shares of stock are currently on the market.
Market share can also vary from what is known as the book value. When the stock is priced under the book value, it is considered to be undervalued, which means trading is occurring at a discount. Though trading over book value does not always mean the stock is overvalued. It could mean that there was a catalyst that has caused the price of the stock to increase.
Free-Float Market Cap vs. Market Cap
While the market cap is based on the total value of all of the company’s shares of stock, the float is the number of stocks that are available for the public to trade. You will calculate the free-float market cap by excluding the locked-in shares, which are those held by the executives of the company and the government. This method of calculation has been adopted by most of the world’s major indexes.
What Is Capitalization Ratio?
Market capitalization is valuable for making a comparison between the market value and the value of the business, and one way to better evaluate this information is by determining the book-to-market ratio. You can determine the book value by investigating the business’s historical cost in the market. To get the book-to-market ratio, you will need to take the common shareholders’ equity and divide it by the market capitalization. This will provide you with a better grasp of the market value of the company more than its actual worth.
How Can Traders Use Market Cap to Make a Better Analysis?
The market capitalization can allow you to look past the current stock price and get a better idea of the value of the company. For example, you may be looking to invest in a company that has shares available for a price of $300 or another company with shares at $50. At first glance, it may seem that the company with a higher price per share would make a better investment. This is not necessarily true. If the first company were to have a market cap of $175 billion and the other had a market cap of $240 billion, then the first glance does not seem as cut and dried as it should. By looking past the stock price and incorporating the market cap, you will get a broader picture of how the market may value the company.
Market cap is very useful information when traders are making decisions on what to invest in. With the market capitalization, you will be able to determine the size of the company, what class it falls in, and better determine the risk that is involved in making the trade. It is important to note that the market capitalization is not the only factor you should use when determining whether an investment is right for you. You should perform the proper research and look at other metrics and indicators before making a decision. Want to get a better handle on how to properly value a company to make the best investment decisions? Download our free e-book or sign up for our online webinar.