Table of Contents
- 1 What is Market Capitalization?
- 2 Market Capitalization Formula
- 3 The Concept of Free-float Market Capitalization
- 4 Example of Market Capitalization & Free-float Market Capitalization
- 5 Types of Market Capitalization
- 6 Uses of Market Cap
- 7 Limitations of Market Cap
- 8 Change in Market Cap
What is Market Capitalization?
Market Capitalization also called as Market Cap, means the market value of the company’s outstanding shares. Its measurement is by multiplication of stock price with outstanding shares. Market value is a great measure to value the companies if the price to earnings ratio (P/E ratio) of the two companies is the same.
Market Capitalization Formula
The formula of Market Capitalization is as follows
Market Capitalization = Outstanding shares * Market price of each share
Outstanding shares means a number of shares issued by the company. The market price of the share means price prevailing in the market i.e. price you need to pay to purchase the share.
The Concept of Free-float Market Capitalization
Free float market capitalization considers only those shares which are readily available for trading in the market. Shares held by Promoters, the government are generally not available for trading in the market. For calculation of Free-float market capitalization, outstanding shares are reduced by a number of shares which are not available for trading.
Example of Market Capitalization & Free-float Market Capitalization
|A. Outstanding shares||5,000,000 (5 Million )|
|B. Numbers of shares held by Promoters||1,000,000 (1 Million)|
|C. Number of shares readily available for trade (A-B)||4,000,000 (4 Million )|
|D. Market price per share||$ 20|
|E. Market Capitalization of a company (A*D)||$ 100,000,000 (100 Million dollar)|
|F. Free float market capitalization (C*D)||$ 80,000,000 (80 Million dollar)|
Types of Market Capitalization
Small cap companies
- When companies market cap is between the US $500 million to the US $ 2 billion, then it would be called as a small cap company.
- Small cap companies are considered as risky for investment compared mid & large cap companies.
- The small company generally have more growth potential.
- The mid-cap company is those whose market cap is more than the US $ 2 million & less than the US $ 10 million.
- In the time of recession, a smaller company may get out of business but not the mid-cap companies.
- It has more growth potential compared to large-cap companies.
- Large companies have a market cap of over US $ 10 billion. They are also called as blue-chip stocks.
- Large-cap stocks are comparatively safer than mid & small cap companies.
- Large-cap companies information availability is higher compared to mid & small cap companies.
Uses of Market Cap
Determines the size of the company
The market cap helps to determine the size of the company. Large market cap of the company reflects well-known companies within an established industry.
Market cap also defines a company’s stage in development. Large-cap stocks are considered more conservative than investment in small/mid-cap companies.
Limitations of Market Cap
Market cap can be helpful for decision making but it is the not only factor that can help the investor in an investment decision. Which means an investor cannot take investment decision on the basis of market cap only. Enterprise value is more useful in case of investment decision.
Change in Market Cap
There are several factors that can impact the market cap of the company. The issue of shares by the company, buy-back/repurchase by the company, significant change in the price of the stock i.e. sudden rise/fall in price could impact market cap.
Market cap is not altered because of a stock split or dividend. Although the number of outstanding shares is increased because of the stock split but the market price of the stock decreases. For example stock split is 2 for 1, means 2 shares for 1 each, in this case, the share price will be halved. The same will happen in the case of a dividend, the price of the share will be reduced by the dividend amount.1–3