Market Capitalization

One of the most effective methods of determining a company's valuation is to look at its market capitalization. When making an investment decision, investors frequently compare companies of similar size.
But how do you measure a company's size?
There are several methods for determining the size of a company. However, one of the most common methods is to examine its market capitalization, also known as market cap.

Market capitalization is a company's market value based on the total value of all publicly traded outstanding shares. This implies that you cannot calculate a market capitalization for companies that are not publicly listed.

In other words, it calculates the cost of purchasing every publicly traded share of a company at its current share price. A company's market capitalization only reflects its equity value.

Whenever you invest in any company, you’re looking for its market cap to rise. This can’t happen unless buyers are paying higher prices for the shares, making your investment more valuable
— Peter Lynch

To calculate a company's market cap, you'll need to know two things about its stock. The first thing you need to know is the stock's share price, and the second is the number of outstanding shares.
Share price— A share price is the cost of buying one share of a company. A share's price is not fixed and fluctuates according to market conditions.
Outstanding shares— The number of outstanding shares is the number of shares in a company that are traded on the secondary market and hence available to investors.
For example, suppose a company issues 1000 shares in total.
600 shares are issued to the general public as floating shares, 200 shares are issued as restricted shares to company insiders, and 200 shares are held in the firm's treasury.
In this case, the company has 800 outstanding shares and 200 treasury shares.

The formula for market capitalization is:
Market Cap = Share Price x Shares Outstanding

market cap formula

The market cap is calculated by multiplying the share price by the total number of outstanding shares. And the higher the market capitalization, the bigger the size of the company.

There isn't a rule that defines the size requirements for each company. However, companies are classified into one of three categories based on their market capitalization: small cap, mid cap, or large cap.

Market Cap Range
Market Cap Range

A small-cap company has a market capitalization of less than $2 billion.
A mid-cap company has a market capitalization of $2 billion to $10 billion.
A large-cap company has a market capitalization of more than $10 billion.

Companies were traditionally classified as large-cap, mid-cap, or small-cap. Mega-cap and micro-cap have also become extremely common, and nano-cap is  sometimes heard.

Large-cap companies typically have a market capitalization of $10 billion or more. Large-cap companies frequently have a reputation for producing high-quality goods and services, as well as a track record of consistent dividend payments and steady growth. Investing in large-cap companies may not yield large returns in a short period of time, but in the long run, these companies generally reward investors with consistent increases in share value and dividend payments.

Mid-cap companies are those with a market capitalization of between $2 billion and $10 billion. These are typically well-established businesses in industries that are experiencing or are likely to experience fast development. Because they are not as well-established as large-cap companies, they face a larger risk, but they are appealing for their growth potential.

Small-cap companies are those with a market capitalization of $300 million to $2 billion. These are typically young businesses that serve niche markets or emerging industries. Because of their age, the markets they serve, and their size, these companies are considered higher-risk investments.

Small-cap stock prices are more volatile and less liquid than those of more mature and larger companies. At the same time, small businesses frequently offer more opportunities for growth than big businesses.

Low Vs High Market Cap
Low Vs High Market Cap

In general, large companies tend to have more stable and mature businesses and having proven themselves over time and whether difficult business conditions they're able to emerge even stronger.

However, the growth prospects for these large companies tend to be more limited because they've already grown so much and sees so much the opportunity in front of them by contrast smaller companies have a lot more room to grow.

However smaller companies tend to be riskier and younger with business models that haven't been proven out over time their odds of failure are significantly higher than those of the more stable large companies.

Most of the best-known companies in the world are large caps and some investors break out stocks with market caps of more than 200 billion into a separate category i.e. mega cap stocks

How to use Market cap?

Most investors find that diversifying their portfolio with large-cap, mid-cap, and small-cap companies allows them to customise their desired return and risk levels to their particular requirements.
If you want your portfolio to be more stable, you should invest more in large cap stocks.
Large cap stocks, on the other hand, are often preferred by those seeking higher levels of current income because they offer dividends.

If you don't need much income and your primary goal is for your portfolio to grow as much as possible over time, you'll probably want to make larger investments in small and mid-cap stocks.

Market capitalization helps us categorize  companies and compare them apples to apples.

Let say, you have two companies ABC enterprises and PQR LLC. The stock of ABC Enterprises is worth $50, whereas PQR LLC is worth $40.
Now which one is the more valuable company?
You can't tell until you know how many outstanding shares each company has.
Assume that ABC Enterprises has 200 million outstanding shares and PQR LLC has 300 million outstanding shares.
Now, ABC Enterprises now has a market capitalization of $10 billion, whereas PQR LLC has a market capitalization of $12 billion. As a result, despite its lower share price, PQR LLC is a bigger company.

The market cap of a company is a far better indicator of its status than its share price, which is why it's important to know the size of a company you're buying before you buy it.

Investors can now compare companies of similar size using these categories. They can also use these categories to build investment portfolios with similar-sized companies or a diversified portfolio with companies of various sizes.

Remember that a market cap is one way to measure a company's size, and it can assist investors in grouping companies by size for easier comparison.

FAQs on Market-Cap

The total value of a company's stock is used to calculate its market capitalization. The quantity of outstanding shares available for public trade is known as the float.
Locked-in shares, such as those held by corporate leaders and governments, are not included in the free-float approach of computing market cap.
Most of the world's main indexes, including the Dow Jones Industrial Average and the S&P 500, use the free-float approach.
Market capitalization informs investors about the size of a company. Market capitalization assists us in categorising businesses and comparing them apples to apples.
Small-cap stocks have outperformed large-cap stocks in the past, but they are also more volatile and risky.
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