Finance 101: What is “Market Capitalization?”
The market capitalization of a firm is the dollar value of all of its outstanding shares of stock. This number, rather than sales or total assets, is used by the financial sector to evaluate businesses.
The market capitalization of a target company is one metric that is used by buyers to decide if an acquisition is a worthwhile investment.
KEY POINTS
- The value of a firm on the stock market is known as its market capitalization. It is the sum of a company’s share price and the market price of all of its shares.
- Market capitalization is just the current share price multiplied by the total number of outstanding shares.
- Large-size companies have a market cap of $10 billion or more, whereas mid-caps have a cap of $2 billion to $10 billion, and small-caps have a cap of $300 million to $2 billion.
- The market capitalization of a firm is a common metric used to assess its size and profitability relative to other businesses.
- Larger market capitalizations typically signify more stable businesses that have been around for a while, making them safer investments for investors.
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Understanding Market cap
It’s crucial to know the value of a firm, but it can be tough to do so fast and accurately.
Values of publicly traded enterprises can be estimated with relative ease using market capitalization, which simply extrapolates the value that investors place on the company.
To calculate the value of a company’s shares in this situation, one needs just to multiply the share price by the total number of shares.
A company’s share price is set by market forces once it has gone public and begun trading on an exchange.
Increases in the share price are possible if there is a significant demand for its shares because of positive causes.
Shares of a corporation could fall in price if investors are pessimistic about its future prospects. Hence, the market capitalization provides an immediate evaluation of the firm’s worth.
How to Determine Market Cap
Market cap is calculated using the following formula:
Market Cap = Current Share Price * Total Number of Shares Outstanding
If a firm had 20,000,000 shares, and each share sold for $100, the market capitalization of the company would be $2,000,000,000. In contrast, a second firm with a share price of $1,000 and only 10,000 shares outstanding would have a market capitalization of only $10 million.
The value of a company is originally determined during its first public offering (IPO).
Prior to an initial public offering (IPO), a firm will hire an investment bank to use valuation tools to establish the fair market value of the business, the number of shares to be offered, and the first offering price.
To illustrate, if an IPO is valued at $100 million by the firm’s investment bank, the company has the option of issuing either 10 million shares at $10 per share or 20 million shares at $5 per share. The initial market capitalization would be $100 million for both scenarios.
Market Cap and Strategies on How to Invest
The market capitalization is a simple and useful tool for assessing risk, and it can be used to narrow down the pool of potential stock investments and facilitate the creation of a diversified portfolio.
Companies with a market cap of $10 billion or more are classified as large-cap or big-cap. These corporations have deep roots in their respective fields and consistently rank among the top performers in their respective markets.
Though investing in large-cap firms may not yield immediate profits, it usually pays off in the long run through dividends and share price appreciation.
Large-cap firms include Apple Inc., Microsoft Corp., and Alphabet Inc. (the parent company of Google).
A mid-cap company is one with a market cap between $2 billion and $10 billion. Companies with a mid-cap valuation are well-established businesses that typically operate in dynamic markets.
Mid-sized businesses currently are undergoing growth. Small and medium-sized enterprises (SMEs) have a higher risk profile than large-cap corporations due to their lack of history and infrastructure, but their expansion prospects are more alluring. Eagle Materials Inc. is a good illustration of a mid-cap firm (EXP).
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micro-cap companies are those with a market worth between $300 million and $2 billion. These organizations may be more recent in age, or they may cater to specific clientele in emerging sectors.
Because of their size, the industries they operate in, and their age, these businesses are viewed as riskier investments.
When economic downturns, smaller businesses with fewer resources feel the effects more acutely.
Thus, micro-cap stock values are more erratic and less liquid than those of larger, more established corporations.
While large caps are safe bets, tiny caps can offer more room for expansion. Companies with a market capitalization of between $50 million and $300 million are classified as micro-caps.
Keep an eye on this space for part 2 on Market Capitalization.
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