What Is Market Capitalisation?
If you read articles about the stock market chances are you will come across the term market capitalisation at some point. But what is market capitalisation? Why is market cap important? And what can it tell you about a company?
In this article, we will answer these questions in detail. Furthermore, we will demonstrate how to calculate market cap and much more!
Table of Contents
What Is Market Capitalisation?
Market capitalisation, often shortened to market cap, is the total market value of a company's outstanding shares, usually expressed in the currency in which the company's shares are listed.
A company's market capitalisation indicates its overall size. This can tell a potential investor a lot about the prospect of investing in the company, which we will look at in detail later.
How to Calculate Market Cap
Market capitalisation is calculated by multiplying a company’s total number of outstanding shares by its current share price.
| Market Cap = Total Number of Shares Outstanding x Current Share Price |
For example, let’s say that Company X has 500,000 shares outstanding at a current market value of $100 per share. The market cap of Company X would be $50 million (500,000 x 100).
Market Cap Categories
Investors traditionally categorise companies into large-cap, mid-cap and small-cap. More recently, however, the terms mega-cap, micro-cap and even nano-cap have also become widely used.
Below is a table which shows how these different market cap categories are typically defined but, bear in mind, there are no set rules here. It is common for companies to move through these categories, as they grow in size or depreciate in value over time.
Why Is Market Cap Important?
Market capitalisation is by no means a comprehensive measure of how much a company is worth. However, it provides us with a quick, and easy to obtain, estimate of a company’s current value.
The subsequent indication of a company’s size allows us to make some deductions about the company in question. For example, you can tell quite a lot about a stock’s potential risk and reward from its market capitalisation.
Small-Cap Stocks
Investing in small-cap stocks typically carries a higher level of risk than investing in larger-cap companies. However, with a higher level of risk also comes a higher level of potential reward, as smaller companies have more room to grow.
Companies which have lower market caps are more susceptible to being pushed out of the market by competition from other small companies or larger companies diversifying their business to establish themselves in a different industry. They are also more vulnerable to economic downturns or recessions due to their lower levels of resources when compared to larger companies.
However, if an investor picks the right company, investment in a small-cap company can be rewarded handsomely. Many of the world’s top stocks, such as Amazon, were small-cap stocks when they first listed.
Moreover, companies with a small market cap are likely to have more volatile share prices. This can make them more appealing to short-term traders who are looking to profit from volatile markets.
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Large-Cap Stocks
In general, companies which have a large market cap are well established in their particular industry. The shares from these types of companies are sometimes called "blue chip" stocks.
An investment in these companies carries lower risk than others, as they have already achieved a certain level of success, beaten off competition and cemented their position as market leaders.
However, whilst investments in large-cap companies typically carry less risk, they also have lower potential reward. The reason for this being that, by definition, these large-cap stocks have already achieved success and, therefore, already experienced high levels of growth. When businesses reach this level, growth inevitably slows down.
Due to their lower risk and steady growth, large-cap companies could be an option for those seeking a long-term investment and have a low appetite for risk. Companies with high market cap are also more likely to issue dividends to their shareholders, making them better candidates for income investments.
Free Float Market Cap
Another, related, term you may have come across, particularly when dealing with stock indices, is the free float market capitalisation.
Whereas the market cap calculation takes into account all a company’s outstanding shares, the free float figure only uses the shares which are freely available in the market.
In other words, it excludes any shares "locked in" and held by company management, controlling parent companies or governments.
Companies which have a small free float market capitalisation in comparison to their market capitalisation, are likely to have a more volatile share price. This is because there is a smaller supply of shares in the market to accommodate any significant changes in demand.
Is Market Cap a Good Indicator for Purchasing Stocks?
Whilst market capitalisation can provide an investor with a good indication of a company's risk vs. reward profile, it should by no means be used on its own when evaluating the merits of a potential investment.
If you are looking to profit from a share's volatility, then smaller cap companies are likely to be more attractive for you. But, in this case, you will also want to look at other factors such as news and economic events.
On the other hand, if you operate over a longer time frame and have a lower appetite for risk, then large caps may be more suitable. However, it is important to look beyond market capitalisation and delve deeply into the fundamentals of a company before deciding whether or not it is a worthwhile investment.
In neither case will market cap on its own give you all the answers you are looking for.
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FAQ
Is higher market cap better?
A large market capitalisation indicates that a company has already had a fair degree of success in its industry. Such companies may have less future growth potential than small cap companies, but also potentially carry less investment risk. Whether or not this makes them “better” depends entirely on the individual company and also on the goals of the investor asking the question.
How many companies have a market cap over 1 trillion?
At the time of writing, there are seven listed companies in the world with a market cap over $1 trillion. These are - in descending order - Apple, Microsoft, Nvidia, Amazon, Alphabet, Saudi Aramco and Meta Platforms. However, bear in mind that this list is subject to constant change as a company’s market cap fluctuates.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
