Market Capitalization Meaning
Market capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share. It is an indicator of a publicly-traded company’s size, risk, and returns.
To determine the size of a company, investors prefer market capitalization over total sales and total assets. This valuation tool facilitates the comparison of different firms, resulting in a balanced portfolio. Market Capitalization is popularly known as market cap.
- Market capitalization is a corporate valuation of a company in terms of market price of outstanding shares.
- Market cap is computed using the formula; Market Capitalization = Number of Outstanding Shares X Price Per Share.
- It is a parameter for determining the size of a firm based upon its market value. Investors use this tool to figure out the risk and returns associated with a company’s stocks.
- This valuation tool overlooks the company’s balance sheet making it unsuitable for mergers and acquisitions. In such a case, computing the enterprise value becomes essential.
Market Capitalization Explained
Market capitalization is a broader concept that indicates investor sentiments rather than balance sheet figures. It is the determinant of a company’s size evaluated as the total value of its current outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.. For example, if the outstanding shares of Company X is 10,000 and the current price per share is $10, then market cap = 10,000 x $10 = $100,000.
It is a widely accepted method among investors. Moreover, it is used to ascertain the risk involved in a company’s stocks and prospective returns. Therefore, investors and portfolio managersPortfolio ManagersA portfolio manager is a financial market expert who strategically designs investment portfolios. compare the market caps of firms to create a balanced portfolio. After all, a company with a high market cap has managed to gain investors’ confidence.
Other than the investors’ confidence, various other factors impact the market cap of a company. These include market fluctuation, reputation, demand, competitor performance, and market buzz.
Despite being popular among investors, the market cap cannot determine a company’s equity valueEquity ValueEquity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding.. Tools like enterprise value figures are preferred. An enterprise valueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover. indicates a firm’s actual financial position. The market cap comes with another disadvantage; stock prices are often over-valued or under-valued. This potentially leads to an inaccurate valuationValuationDiscounted cash flow, comparable company analysis, comparable transaction comps, asset valuation, and sum of parts are the five methods for valuing a company..
Types of Market Cap
Market cap can be differentiated based on its size. Given below are the four categories of market capitalization:
#1 – Nano Cap
These are the companies whose total shares are valued below $50 million and therefore called penny stocksPenny StocksPenny Stock refers stocks of public companies that trade at a very low price, typically less than $5 per share and are highly illiquid. Usually, these stocks belong to small and newbie companies with a low market capitalization.. Such firms have the lowest market cap and are considered high-risk. Example: Ever-Glory International Group, Inc.
#2 – Micro Cap
The market cap of these micro-capMicro-capStocks with a market capitalization of $50 million to $300 million are known as micro-caps. The market capitalization of such stocks is higher than that of nano-cap firms, but lower than that of small-cap, mid-cap, and large-cap companies. companies ranges between $50 million and $300 million. These stocks have low value, and their financial reports are not filed with the SEC. Thus, investors must be careful; there is little publicly available information. Example: Arch Coal, Inc.
#3 – Small Cap
The small-cap companiesSmall-cap CompaniesSmall-cap stocks are stocks of relatively small companies with market capitalizations ranging from $300 million to $2 billion, and they are popular among investors who want a high return with a high risk. are rapidly growing business entities and have a market cap ranging between $300 million and $2 billion. Such stocks usually provide good returns but hold an equal risk level. Also, the share prices of small-cap funds are affordable to investors—for example, BEST Inc.
#4 – Mid Cap
Companies with a market capitalization of $2 billion to $10 billion are categorized under the mid-cap stocksMid-cap StocksMid-Cap stocks are the stocks of the companies having medium market capitalization. Their capital lies between that of large and small cap companies and valuation of the entire share holdings of these companies range between $2 billion to $8 billion.. These companies provide balanced risks and return to the investors. They show a stable performance or growth in the long run—for example, Akamai Technologies Inc.
#5 – Large Cap
Large CapsLarge CapsLarge-cap stocks refer to stocks of large companies with value, also known as the market capitalization of 10 billion dollars or more, and these stocks are less risky than others and are stable. They also pay a good dividend and return, and it is the safest option to invest. are well-known and established companies with a market cap exceeding $10 billion. Expectedly, the stocks of such business entities are expensive and bear minimal risks compared to the other options. Example: Facebook, Inc.
Market Capitalization Calculations
The market capitalization of any company can be calculated using the following formula:
Market Capitalization = Number of Outstanding Shares X Price Per Share
Let’s now calculate the market cap of Cisco Systems Inc.
According to Bloomberg:
- CSCO: US Price Per Share = $57.87
- Number of Shares Outstanding = $4.22 billion (4220000000)
Market Cap FormulaMarket Cap FormulaThe Market Capitalization formula determines the company's total equity value by multiplying the current market price of each share with the total number of outstanding shares. Market Capitalization Formula = Current Market Price per share * Total Number of Outstanding Shares. = Number of Outstanding Shares X Price Per Share
Market Cap = 4,220,000,000 X 57.87
Market Cap = $244,211,400,000 or 244.211 billion
Market Capitalization Examples
Some of the most prominent US companies valued based on their market capitalizations are as follows:
- Apple Inc. (AAPL): Apple’s market cap is $2.448 trillion, which is the highest worldwide; the per-share value of AAPL is $148.12. The earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. (EPS) in the trailing twelve months is $5.16 per share.
- Microsoft Corp. (MSFT): Microsoft is valued at $2.253 trillion, and each unit of MSFT is worth $299.79. Also, the recent year’s EPS is $8.12.
- Alphabet Inc. (GOOGL): Ranking third with a market cap of $1.908 trillion is Alphabet, whose per-share value is $2850.89. Further, each stock made $93.42 in the last twelve months.
- Amazon.com, Inc. (AMZN): Amazon’s market cap is worth $1.747 trillion, and the price of each share is $3450, which is remarkably high. Further, each of its shares yielded $58.51 in the trailing twelve months.
Limitations of Market Cap
Market caps do not show the actual figures. That means the market cap calculation cannot be adopted as the sole valuation measure for making a major decision. Instead, the enterprise value is a better option; it is based on a firm’s takeoverTakeoverA takeover is a transaction where the bidder company acquires the target company with or without the management's mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers. value. The enterprise value accounts for the total debt. The enterprise value deducts cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. for finding out the actual takeover value. Market cap fails to evaluate a company’s worth in case of an acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion. or mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm..
Market Capitalization vs. Shareholders’ Equity
Both the market cap and the equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet. are used to analyze corporate growth; however, if the former surpasses the latter, it reflects the investors’ high confidence in a company.
Mentioned below are some of the primary differences between these two measures:
|Basis||Market Capitalization||Shareholders’ Equity|
|Meaning||Market capitalization is the total value of all the corporate shares floating in the market.||The equity or shareholders’ equity is the actual net worth of a company.|
|Formula||Market capitalization is the product of total outstanding shares and each share’s market value. (Number of Outstanding Shares * Price of Each Share)||It is computed as corporate assets minus liabilities. (Total Assets – Total Liabilities)|
|Indicates||It indicates the firm’s size based on investor interest and demand for shares.||It reflects the actual net worth in terms of assets and liabilities.|
|Appears on||Company’s annual report and represented as the number of outstanding shares and the value per share||Company’s annual report and balance sheet|
|Affects the index||Yes||No|
Frequently Asked Questions (FAQs)
Market cap is the absolute market value of any company, determined as the total value of its outstanding shares. In other words, it is an evaluation of a company’s size in terms of the overall price of its outstanding stocks. The market cap overlooks debt in its corporate valuation, which is its main drawback.
Market cap plays a significant role in deciding where to invest. It serves as a tool for deciding whether a company is worth investing in. Investors use this tool to analyze a company’s size and market standing. Also, it ascertains various parameters for risk and returns.
Apple Inc. is a pioneer in electronic technology. It is the most significant company based on market cap. Its market cap is worth $2.448 trillion, and the price of an AAPL unit is $148.12.
Video on Market Capitalization
This article has been a guide to what is Market Capitalization and its meaning. Here we discuss types of market cap, examples, calculations, and limitations.