Market capitalization is the value of total outstanding shares that a company or corporation has. The value of market cap is usually estimated in US dollars, and determined by the stock market.
Adequate knowledge of the market capitalization will help an investor to decide what action to take when faced with an investment opportunity. You can calculate the Market cap easily by multiplying the company’s total outstanding shares by the current market price of one share.
How Does Market Cap Work?
Market capitalization is an estimated index of the company’s size, and can be determined by two factors namely:
- The outstanding shares of the company
- The market price of the shares.
When any of the above factors decreases in value, the market capitalization also decreases in value. For example, if the market price of a company’s shares decreases by 20%, the market capitalization will also decrease by 20%, provided that the number of shares remains constant.
A market cap gives a relatively accurate prediction of its potential for future growth. Companies with smaller market cap have greater growth potential, hence, they offer greater risk and potential for return on investment. Following the rule; the greater the risk, the greater the reward or loss. As a result, companies with larger market capitalization offer lesser growth potential and are less likely to incur a loss on investment.
What Does Market Cap Tell You?
The market cap is a more accurate index for the company size and must be common knowledge to the investor before he/she takes action. Investors usually have a list of companies or entities to choose from and may be misled by the price of the share. To avoid being misled, an investor can use the market cap to compare two or more companies’ sizes.
Companies with larger market cap pose less risk, with correspondingly lower growth potential. On the other hand, companies with smaller market cap pose a higher risk, with correspondingly greater growth potential.
Why Is Market Cap Important?
Since a market cap is a metric for analyzing company size, it is useful in evaluating risk and potential for reward for a stock of a company. The company size gives the investor insight into the potential for future growth of the company and the approximate return on investment.
It further determines the investment strategy, which may be short-term, medium-term, or long-term. Investors may diversify investment, having a combination of any of the groups of market caps in their portfolios.
Before an investment is made, the investor can weigh the odds based on the company size, and analyze the risks associated with each option.
How To Use Market Cap
Market capitalization is used to create the perfect investment strategy, which has a portfolio that offers the minimum amount of risk with the greatest potential of returns. This can only be achieved with a diversified portfolio. A diversified portfolio involves a well-defined mix of large-cap, mid-cap, and small-cap stocks.
Large-cap stocks offer the least potential for returns within a short period when compared to small-cap and mid-cap stocks. They’re best suited for long-term investments since they pose a lesser risk.
Small-cap stocks, however, offer the greatest potential for returns within a short period, in comparison with other stocks. They’re best suited for short-term investments since they pose a lesser risk and are most volatile.
How To Calculate Market Cap
Market cap is calculated by multiplying the current price of a company’s shares by the total number of outstanding shares.
For example, a company with 30 million shares selling at $100 per share has a market cap of $3 billion. Such a company is referred to as mid-cap.
The formula for calculating a company’s market capitalization is:
Market Capitalization = Current share price × Total number of outstanding shares
What Is Float-Adjusted Market Cap?
A float-adjusted market cap is the market cap of only the actively traded shares in the open market. It may also be regarded as a free float market cap. Float is defined as the shares that are available for public trading. A float-adjusted market cap measures the number of shares that can be publicly traded and is estimated using the free float method.
The shares estimated do not include “locked-in” shares, such as shares owned by the government or company executives. The locked-in shares may never be sold, depending on ownership; hence, they are not estimated in the float-adjusted market cap.
Examples of Market Cap
Apple Inc became the first company to reach a market capitalization of $1 trillion, in 2018. Amazon and Microsoft joined Apple, not long after. Two years later, Apple Inc doubled their market capitalization, exceeding $2 trillion, marking another record. Only seven countries have their annual GDP figures to be greater than the market cap of Apple Inc. Apple’s market cap remains the greatest of any publicly-traded company.
Another example is the coin market capitalization. This is otherwise known as the crypto market capitalization. It is the market value of a particular cryptocurrency. The coin market cap is easily calculated by multiplying the current price of the coin by the total number of the coin in circulation. Similarly, it is an index of the size of the digital market.
For example, if an altcoin is valued at $50, and the total circulating supply is 10 million coins; the market cap for the coin equals $500 million.
The total market cap is a sum of the individual market cap for each coin in the crypto market. It encapsulates the market cap of each coin in the digital market and can be calculated by summation of the market caps of the coins in the cryptocurrency market.
Two factors determine the coin market cap. They include:
- The circulating supply
- The coin value
Cryptocurrencies have a limiting circulating supply, with the total circulating supply of one coin being greater than the other. The relationship between the circulating supply and the coin market supply is expressed in such a way that the former is directly proportional to the latter.
The circulating supply may also affect the price of a coin. Coins with a larger circulating supply are usually less expensive than those with fewer supplies. Scarcity affects the value of a coin, as such, coins with greater demand than supply tend to increase in value.
As of March 21, the total crypto market cap was estimated to be $1.77 trillion. The coin market of bitcoin represents 60% of the total crypto market cap, with a value of $1.07 trillion.
Market Capitalization Categories
Using market capitalization as the criterion, company size may be grouped into the following into three major categories: large-cap, mid-cap, and small-cap companies. However, there are some lesser known categories as well. Let’s review, compare and contrast them all.
Mega-cap Companies
These are companies with a market cap of $200 billion and above. They constitute a significant part of the market. Apple Inc, for example, is 4.56% of the total shares traded in the top U.S. stock exchanges. Mega-cap companies are less volatile and offer less risk.
Large-cap Companies
These are companies with a market cap of $10 billion and above. These companies have lasted in their niche over a long period. They may even be pioneers in their niche. They pose less risk in investment and offer lower returns over a short period. Large-cap companies are most suitable for long-term investments since they’re most likely to remain in their industry. They are known to pay consistent dividends to investors. An example of this is Microsoft.
Mid-cap Companies
These are companies with a market cap of $2 billion to $10 billion. They show greater potential for growth than large-cap companies and lesser risk than small-cap companies. They are in the process of growth, which may directly increase their market share.
Small-cap Companies
These are companies with a market cap of $300 million to $2 billion. There are emerging companies that offer the most growth potential since they are young. They may never reach their full potential, due to hindering factors, such as; limited available resources and competition in their niche. Their stocks possess high volatility and carry high risks.
Micro-cap Companies
These are companies with a market cap of $50 million to $300 million. It is comprised of newly listed companies. They are characterized by low and relatively inaccurate information available to the public. Micro-cap companies offer more risk than small-cap stocks. Investors are advised to cautiously invest after carrying through research of the stock.
Market Capitalization vs Enterprise Valuation
Market capitalization only indicates the company size. It faboth market cap and debt.
ils to consider factors like the company’s assets or debt. The company’s market cap is the total value of its equity. Enterprise value, on the other hand, is the summation of Enterprise value= Market capitalization + Total debts
For example, as of October 20, 2020, Apple Inc had a market cap of $2.01 trillion and an enterprise value of $2.03 trillion.
If one was to take over Apple Inc, the individual would not only buy all the common stock, at the value of the market cap but also pay off the debt, valued at $2 billion.
Misconceptions About Market Cap
The most common misconception about a market cap is that it gives the true value of the company. However, this is not the case because a company’s market cap does not involve dividends and debt.
In calculating the market cap, investors may also fail to include locked-in shares. Investors must also be able to differentiate between the total market cap, the float-adjusted market cap, and their significance. Otherwise, their investment strategy may fail. Investors should also understand that ‘outstanding’ shares refer to the total company shares, i.e. both publicly traded shares and locked-in shares.
Balance Is the Best Way to Go
With the large array of options to invest in, an investor must consider the size of the company before diving in. Each of the three major categories of market cap as explained above have their varying characteristics. Consulting a financial advisor will help you make an informed investment decision and which options to invest in, those to stay clear of.
Financial Advisors have an inept knowledge of market capitalization and can guide you through how to diversify. They will also guide you through which options to choose from based on company size and time of investment.
An effective investment strategy will take into account all the three market cap categories so that loss from small-cap stocks may be cushioned by profits from large-cap stocks. This is not always guaranteed, but it’s the safest way to go.