What Is Market Capitalization?
\n\nMarket capitalization, or \"market cap\", is the aggregate market value of a company represented in a dollar amount. Since it represents the \u201cmarket\u201d value of a company, it is computed based on the current market price (CMP) of its shares and the total number of outstanding shares.\n
\n\n\nMarket cap is also used to compare and categorize the size of companies among investors and analysts.\n
\n\n\nKey Takeaways
\n- Market capitalization is the total dollar value of all outstanding shares of a company at the current market price.
- Market cap is used to size up corporations and understand their aggregate market value.
- Companies may be categorized as large-, mid-, or small-cap depending on their market capitalization.
- Blue-chip companies are often large- or mega-cap stocks, while the very smallest are referred to as micro-caps.
Understanding Market Capitalization
\n\nMarket cap is calculated by multiplying a company's outstanding shares by the current market price of one share. Since a company has a given number of outstanding shares, multiplying X with the per-share price represents the total dollar value of the company.\n
\n\n\nOutstanding shares are the total amount of shares\u00a0currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company\u2019s officers and insiders.\n
\n\nFormula and Calculation
\n\nThe formula for market cap is:
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\n\nMarket Cap=Price Per Share\u00d7Shares Outstanding\n
\n\n\nFor example, if ABC Corp. trades at $30 per share and had one million outstanding shares, its market capitalization would be ($30 x 1 million shares) = $30 million.\n
\n\n\nSince the market price of shares of a publicly-listed company keeps changing with each passing second, the market cap also fluctuates accordingly. The number of outstanding shares can also change over time.\n
\n\n\nNote that changes to the number of outstanding shares are infrequent, and the figure changes only when the company undertakes certain corporate actions, such as issuing additional shares through a secondary offering, exercising employee stock options (ESO), issuing/redeeming other financial instruments, or buying back its shares under a share repurchase program.\n
\n\n\nEssentially, the changes in market cap are largely attributed to the share price changes, though investors should keep an eye on corporate-level developments that may change the number of outstanding shares once in a while.\n
\n\nTypes of Market Capitalization
\n\nSince capitalization represents a dollar value that can vary widely, different buckets and associated nomenclatures exist for categorizing the different market cap ranges. Below are the commonly used standards for each capitalization.\n
\n\nMega Cap
\n\nMega-cap companies are those with a market cap of $200 billion or higher. They are the largest publicly traded companies by market value, and typically represent the leaders of a particular industry sector or market. A limited number of companies qualify for this category.\n
\n\n\nFor example, as of Q2 2022, technology company Apple (AAPL) has a market cap of $2.9 trillion, making it the most valuable company in the world; while online retailer Amazon.com (AMZN) came in next at $1.6 trillion.\n
\n\nLarge Cap
\n\nCompanies that are considered large-cap have a market cap between $10 billion to $200 billion. For example, in Q2 2022, International Business Machines Corp. (IBM) and General Electric (GE) are large-cap stocks with market caps of $116 billion and $99 billion, respectively.\n
\n\n\nBoth mega and large-cap stocks are referred to as\u00a0blue chips and are considered to be relatively stable and secure. However, there is no guarantee of these companies maintaining their stable valuations as all businesses are subject to market risks.\n
\n\nMid Cap
\n\nMid-cap stocks range from $2 billion to $10 billion in market cap, and this group of companies is considered to be more volatile than the large-cap and mega-cap companies. Growth stocks represent a significant portion of the mid-caps.\n
\n\n\nSome of the companies may or may not be industry leaders, but they may be on their way to becoming one. First Solar (FSLR), is a mid-cap leader in the solar power field, with a market cap of around $8 billion as of Q2 2022.\n
\n\nSmall Cap
\n\nSmall-cap companies have a market cap between $300 million to $2 billion. While the bulk of this category is comprised of relatively young companies that may have promising growth potential, a few established old businesses which may have lost value in recent times for a variety of reasons also figure in the list.\n
\n\n\nOne example is Bed Bath & Beyond Inc. (BBBY) which has a market cap of $2 billion as of Q2 2022, putting it right on the high-end of small cap stocks. Track records of such companies aren\u2019t as long as those of the mid-to-mega-caps, but they also present the possibility of greater capital appreciation.\n
\n\nMicro Cap
\n\nCompanies that are considered micro-cap consist mostly of penny stocks\u2014this category denotes companies with market capitalizations between $50 million to $300 million. For instance, a lesser-known pharma company with no marketable product and working on developing a drug for an incurable disease, or a five-person company working on artificial intelligence (AI)-powered robotics technology may be listed with a small valuation and limited trading activity.\n
\n\n\nWhile the upward potential of such companies is high if they succeed, the downside potential is equally worse if they completely fail. Investments in such companies may not be for the faint-hearted and require more due diligence.\n
\n\nNano Cap
\n\nNano caps are another high-risk, high-reward layer beyond the micro-caps. Nano-cap companies have market caps below $50 million. These companies are considered to be the riskiest, and the potential for gain varies widely. These stocks typically trade on the pink sheets or Over-the-Counter Bulletin Board (OTCBB).\n
\n\n\nHistorical analysis reveals that mega- and large-caps often experience slower growth with lower risk, while small-caps have higher growth potential but come with higher risk. It is common to see companies making transitions from one category to the other depending upon the change in their market cap valuations regularly. Along with companies, other popular investments like mutual funds and exchange-traded funds (ETFs) are also categorized as small-cap, mid-cap, or large-cap. In the case of funds, the terms represent the types of stocks in which the fund primarily invests.\n
\n\nImportance of Market Capitalization
\n\nSome traders and investors, mostly novices, can mistake a stock's price to be an accurate representation of that company\u2019s worth, health, and/or stability. They may perceive a higher stock price as a measure of a company\u2019s stability or a lower price as an investment available at a bargain. Stock price alone does not represent a company's actual worth. Market capitalization is the correct measure to look at, as it represents the true value as perceived by the overall market.\n
\n\n\nFor instance, Microsoft with a stock price of around $300 per share had a market cap of $2,3 trillion as of Q2 2022, while Berkshire Hathaway (BRK.A), with a much higher stock price of more than $50,000 per share, had a lower market cap of $761 billion. Comparing the two companies by solely looking at their stock prices would not give a true representation of their actual relative values.\n
\n\n\nWith billions of dollars worth of valuation, a large-cap company may have more room to invest a few hundred millions in a new stream of business and may not take a big hit if the venture fails. However, a mid-cap or micro-cap company making a similar value investment may be susceptible to big blows if their venture fails as they don\u2019t have that bigger cushion to absorb the failure. If the venture succeeds for large-cap companies, it may appear small in their profit numbers. But if the company scales up with its success, it can lead to profits of larger magnitudes. On the other hand, the success of such ventures for a mid-cap company can bolster its valuations to significant heights.\n
\n\nA high stock price in and of itself does not always indicate a healthy or growing company. It can still have a relatively small market cap!
Special Considerations
\n\nValuations of mid-cap or small-cap companies often take a hit when there are reports of a large-cap company encroaching into their space of products or services. For instance, the entry of Amazon into cloud hosting services under the Amazon Web Services (AWS) umbrella has been posing a big threat to smaller companies operating in the niche space.\n
\n\n\nGenerally, investments in mega-cap or large-cap stocks are considered more conservative with less volatility than investments in small-cap stocks. Though mid and small-cap stocks offer high return potential to risk-taking investors, the relatively limited resources at the disposal of such companies make their stocks more susceptible to competition, uncertainties, and business or economic downturn.\n
\n\n\nThe different measurement of Market Cap values also form the basis to launch a variety of market indexes. For example, the benchmark equity index, the S&P 500, includes the top 500 U.S. companies which are weighted based on their market cap value, while the FTSE 100 index includes the top 100 companies listed on the London Stock Exchange with the highest market capitalization. Both indexes use the Float-Adjusted Market Cap Calculation.\n
\n\n\nSuch indexes not only represent the overall market developments and sentiments, but are also used as benchmarks to track the performance of various funds, portfolios, and individual investments.\n
\n\nWhy Are Small-Cap Stocks Often More Volatile?
\nSmall-cap stocks have relatively lower market values because these tend to be younger growth companies. Because of their growth orientation, they may be riskier since they spend their revenues on growth and expansion. Small-cap stocks are therefore often more volatile than those of larger companies. Generally, large-cap stocks experience slower growth and are more likely to pay dividends than faster-growing, small- or mid-cap stocks.
What Is a Market Capitalization-Weighted Index?
\nMany stock indexes, such as the S&P 500, are weighted by market cap. This means that stocks with larger market capitalizations make up comparatively more of the index.
How Do Stock Splits Affect Market Cap?
\nWhen a company undergoes a stock split, it increases the number of shares outstanding while reducing the price of each share by a similar proportion. For instance, in a 2:1 stock split, there will be twice as many shares, but at half the pre-split price. As a result, splits do not inherently influence market cap.
The Bottom Line
\n\nAn understanding of the market cap concept is important for not only the individual stock investor but also\u00a0investors\u00a0of various funds. Market caps can help investors know where they are putting their hard-earned money.\n
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