Market Capital definition
Market capitalisation is one of the simplest ways to measure a company’s size. Here we take an in depth look at market capitalisation and how you calculate it.
What does market capitalisation mean?
Market capitalisation (commonly known as “market cap”) is the total market value of a company’s outstanding shares. Outstanding shares are all of a company’s shares or financial assets that have been authorised, issued, purchased and held by investors. This figure can be used to establish a company’s size, instead of using sales or total assets figures. For instance, you might have heard Microsoft referred to as the most valuable company in the world. This is because the multinational technology company currently has the highest market cap of any publicly traded company.
How to Work Out Market Capitalisation
To calculate market capitalisation, all you need to do is take the total number of a company’s outstanding shares and multiply it by the current price of one share. Therefore, if a company has 3 million shares outstanding and each share is worth $30, then its market capitalisation is $90 million.
Selecting Stocks by Market Capitalisation
Market capitalisation is often used to help inform investment decisions as it helps compare the size of different companies and can give an indication of how established they are and what kind of market share they enjoy for their services or products. This is why investors split stocks into categories based on their market capitalisation, but more on this later.
Also, market capitalisation is a relatively straightforward and simple way to assess risk. This is because larger, well established companies tend to have more stable performance in comparison to smaller start ups.
Whilst there are some benefits of using market capitalisation to help you decide which stocks to invest in, there are also some limitations. For example, a business’s worth, also known as its enterprise value, is not always reflected accurately by the market capitalisation. Only equity value is reflected. There is a chance that share prices might be over- or under-valued because they only show how much the market is prepared to spend for a stock at a certain time.
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Different types of capitalisation
There isn’t a universal way to categorise companies based on their market cap, however they are often categorised like this:
- Mega cap
This category refers to companies that have a market cap of over $300 billion. These are the largest publicly traded companies by market value and usually include the leaders of an industry or sector. As of 20th June 2019, Microsoft had a market cap of $1.048 trillion, followed by Amazon at $942.41 billion and Apple at $913.77 billion (YCHARTS).
- Large cap
Large cap companies have a market cap between $10 billion and $300 billion.
Mega and large cap stocks are known as blue chips and are thought to be fairly stable and secure. With that being said, there is still no guarantee that businesses in this category will keep their stable valuations as all companies can be affected by volatile market conditions.
- Mid cap
This category of companies is thought to be more volatile than mega cap and large cap companies. They have a market cap between $2 billion and $10 billion and a significant proportion of mid caps is represented by growth stocks. Whilst some of the companies in this category aren’t industry leaders, many are on their way to becoming one.
- Small cap
Ranging from $300 million to $2 billion in market cap, the bulk of this group comprises younger companies that may have promising potential for growth. Other companies in this group are established older businesses that have lost some of their value.
Often with small caps there is the possibility of greater capital appreciation as a new company flourishes and grows quickly. But the trade-off is greater risk as some smaller businesses struggle and lose value.
- Micro cap
Companies in this category have a market capitalisation between $50 million and $300 million and it mainly consists of penny stocks. For example, a pharmaceutical company that doesn’t currently have a marketable product. If it strikes it lucky with an innovative or disruptive product, the upward potential of such a company can be high, but if it fails, the downside is the potential for shareholders’ equity to vanish altogether.
For this reason, investing in micro cap companies is a riskier investment, and so extensive research should be carried out before making a decision.
Another high-risk option is companies in the nano cap category. These businesses have a market cap below $50 million. The potential for gains varies widely in this category and stocks usually trade on OTCBB or pink sheets. Pink sheet listings are companies that aren’t listed on a major stock exchange like the New York Stock Exchange.
To summarise, mega and large caps generally experience slower growth with lower risk, whilst small caps have higher potential for growth but can be riskier. Companies often move from one category to another as their market cap grows or shrinks in line with their business.
Popular investments like exchange-traded funds and mutual funds also categorise as small cap, mid cap or large cap, reflecting the type of underlying investments they target.
How do companies increase their market capitalisation?
So, we’ve established that there are two values that determine the market cap of any company: the share price and the number of shares. But how can companies increase their market cap? The main way to achieve this is by increasing their share price. This tends to be based on their performance (and analysts’ perception of that performance). So if they can work on ways to improve this, their share price should increase.
Companies can issue new shares. However, this serves to dilute the value of the existing stock. So, doubling the number of shares on issue won’t double a company’s market capitalisation, even though it will increase the total number of shares outstanding. For example, if a company has 20 million shares outstanding worth $10 each, after they undergo a 2-for-1 split, it will have 40 million shares outstanding but they are now only worth $5 each.