What is Market Capitalization?
Calculating the market cap gives investors a better understanding of how much a company is valued at or worth. This guide will explore market cap and the different market sizes.
Originally published on Zinvest: zvstus.com/blog/what-is-market-capitalization
Definition: What is a Market Cap?
Market capitalization, also known as market cap, refers to the total market value of a company’s shares of stock.
Market capitalization is calculated by multiplying the share price (at current market price) by the number of shares outstanding.
Introduction to Market Cap
Market capitalization is a helpful metric for investors as it measures the size and value of a company in a public market.
The importance of market capitalization gives investors an understanding of return potential and risk assessment from public companies on the exchange.
By calculating the market cap, the outcome reflects the company’s position and what investors may be willing to pay for the shares.
Simply put, a company with 10 million shares outstanding that sells at $50 each would have a market cap of $500 million. The company’s market cap, also known as its equity value, is calculated by multiplying the share price ($50) by the number of outstanding shares (10 million shares).
For a more specific example, The Walt Disney Company (DIS) is currently selling shares for $179, with an estimated 1.8 billion shares outstanding. After calculation ($179 per share times 1.8 billion shares), Disney’s market value is over $323 billion, making it one of the largest companies in market cap.
Keep in mind that a business’s worth, otherwise known as the enterprise value (EV), is reflected as the equity value. A business’s market cap is not reflected by the enterprise value or equity value.
Instead, the EV is a broader method in measuring a business worth and includes the total amount of capital (including the debt) that is invested into a company.
Understanding Market Cap
From Private to Public — IPO
When a company decides it wants to transition from private to public, it must first establish its market cap through an initial public offering, also known as an IPO.
The process begins with an investment bank that purchases the private company’s shares and sells the stock to investors at the IPO.
For example, if a company’s IPO value is $50 million, the investment bank can split this in two ways: the bank can issue 5 million shares at $10 per share or 10 million shares at $5 per share. Either decision will result in an initial market cap of $50 million.
Once a company can publicly trade following an IPO, the share price is determined by investor supply and demand.
Ultimately, this forms a real-time estimate of a company’s market capitalization. If there is a higher demand for a company’s shares, the prices increase along with the market cap and vice versa.
Differences in Market Sizes
As previously mentioned, understanding market caps allows investors to compare the differences in company size and worth among other investors.
Companies are typically categorized as small-cap companies ($300 million to $2 billion), mid-cap companies ($2 billion to $10 billion), or large-cap companies ($10 billion to $200 billion) depending on the aggregate market value.
Additionally, there are nano-cap companies (below $50 million), micro-cap companies ($50 million to $300 million), and mega-cap companies (over $200 billion).
Small-Cap
Typically viewed as young and emerging businesses, small-cap companies may face strong competition, less liquidity than larger industries, and high volatility in stock prices.
Despite this, small-cap stocks offer long-term investors their value through their growth potential and better returns (compared to large-cap stocks). Some examples include AMC Entertainment Holdings, Inc. (AMC) and Rite Aid Corporation (RAD).
Mid-Cap
Mid-cap companies are established businesses sustaining their market position while finding ways to expand their overall growth.
Investing in mid-caps is riskier than investing in large-caps, but this is due to higher return potential. On the other end, mid-cap stocks are generally safer investments than small-cap stocks, as small-caps carry higher risk. Some examples include First Solar, Inc. (FSLR) and American Eagle Outfitters, Inc. (AEO).
Large-Cap
Out of the three, large-cap companies provide investors with stable growth and consistency in share prices.
These businesses are well-established and are major forces in their markets. Large-cap companies offer investors smaller returns with moderate potential for growth by being the safest investment alternative. Some examples include Starbucks Corporation (SBUX) and Target Corporation (TGT).
Micro-Cap
Investing in micro-cap companies, aside from nano-caps, is the riskiest and most volatile option. As most of the stakes are held long-term and invested by institutional investors, these companies are momentum-based due to their high volatility. Some examples include Recon Technology, Ltd. (RCON) and Comstock Mining Inc. (LODE).
Mega-Cap
Mega-cap companies are the largest players in the market and are usually industry leaders. A mega-cap company has the highest equity value and, like mega-caps, provides the most stability and consistency in exchange for lower return potential. Some examples include The Walt Disney Company (DIS), Apple Inc. (AAPL), and Amazon.com, Inc. (AMZN).
If an investor compared market caps based on share prices alone, they would form an inaccurate opinion towards the actual value. Understanding market capitalization helps limit these mistakes.
For example, Company A may have lower stock prices than Company B. However, if Company A was a small-cap and Company B was a micro-cap, Company A would hold a higher value, despite the lower prices in shares.
Conclusion: How Does Market Capitalization Affect My Investments?
Understanding market capitalization is a beneficial tool for all investors.
The metric provides valuable investment information regarding a company’s worth and stability while also being simple to calculate.
Ultimately, knowing the market cap is just one factor in helping investors build strong, diversified portfolios. Owning shares from different market caps can improve potential gains while balancing out any additional risks.
