What is Market Capitalization?
Market capitalization or market cap refers to the size of the company, which is calculated based on the market price of the company’s shares and the number of its outstanding shares. In other words, its the market value of a company that is determined by the stock market.
The market cap of a company is calculated by multiplying the outstanding/number of shares of the company with the price of each share. So, lets understand this with the help of an example. Lets say Company ABC has a total of one million shares in issue and the price of each share is $10, then when you multiply both of these you would get its market cap, which is $10 million.
Market cap = Current market price of a share X Total number of outstanding shares
Market cap helps an investor to know the risks associated with the company and help him understand the size of the company and the growth opportunities that it has.
Market cap of a company does not show the true value of the company. The company might be overvalued or it may be undervalued. The demand of supply for these shares determines the market cap of a company. For example, an undervalued company may have assets that are worth more than its market cap, but this may have gone unnoticed by the market. Only a thorough analysis of a company can help in understanding its true value.
The market cap of a company maybe affected by share buybacks, share issues or when an investor exercises his warrants. When a company buys back its own shares, the number of shares in the market reduce and this may mean that the demand for those shares is greater than its supply. It means that more investors are now competing to buy those shares. This may lead to its price going up.
On the other hand, when a company issues bonus shares, shares to raise funds or when an investor exercises his warrant, the number of shares in the market increase. This means that there are more number of shares in the market and the value is now diluted. Hence this may lead to its price going down.
Market cap has three broad categories, they are:
These are the companies which have a market cap that is between $2 billion and $10 billion. In India, these companies are those which have a market cap of more than ₹20,000 crores. The market cap may differ from country to country. These are usually the companies that are stable and mature and grow at a very slow pace. Investing in these usually doesn’t help an investor earn a higher return. The only way to earn higher return from them would probably be during market crashes. These companies usually provide a steady flow of dividends.
These companies are the ones whose market cap is between $300 million and $2 billion. In India, the companies with a market cap that is between ₹5,000 crores and ₹20,000 crores are said to be mid-cap companies. These companies are usually new and still have some room for growth. These are riskier than the large-cap companies but they provide a higher return for the risk that is taken by an investor. They may or may not pay dividends as these are still growing and may decide to use their profits to grow and expand.
The companies whose market cap is between $50 million and $300 million are known as small-cap companies. In India, the companies with a market cap that is below ₹5,000 crores are known as small-cap companies. These are small and young companies which have a lot of room for growth. The stock prices of these companies are usually more volatile when compared to those of the large-cap and mid-cap companies. The risk in investing in this companies is on the higher side and so are the returns. They usually do not pay dividends. Economic trends may affect them more than the companies in the other categories.
Like I mentioned before the market cap of a company does not necessarily show its true value. Its one of the ways to classify the companies according to their size and to help an investor gain an idea about the company.
Thank you for reading this post. I hope that I was able to clear your doubts about Market Capitalisation.
Please let me know about your opinions and suggestions in the comments below.
Please do share this post.