The market capitalization definition describes the formula used to find the overall market value of a company. This is calculated by multiplying the total number of a company’s outstanding shares by the current price of one share. Outstanding shares are the total stock held by all shareholders and can vary in volatility due to share price. The price of shares can fluctuate according to the company’s supply and demand. This makes up the market cap of a company when both values are combined.
A generic example of this would be if a company had an outstanding share of 40 million shares and a price of $35 per share. To find the market capitalization, you would calculate this as such:
40 million x $35 = $1,400,000,000,000
Market capitalization allows for investors to get a bigger picture of a company’s size and public market value. With this information, investors are able to measure future expectations of companies in which they want to invest. The higher the value of a single company means the bigger business that it will draw in time.
One real-world example of a big business would be Apple Inc. Currently, this company has a total of 17 billion outstanding shares and an average share price of $118.32. Let’s take a look at how the market capitalization calculation would look in this scenario:
17 billion x $118.32 = $2,011,440,000,000
Now that we have a basic definition, let’s take an in-depth look at market capitalization as one metric of fundamental analysis.
Before we continue, Financial Professional wants to remind you that this article is educational in nature. Any securities or firms named are for illustrative purposes only and do not constitute financial advice. Always do your due diligence and consider your situation – and the help of a licensed financial professional – when making investment decisions.
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Understanding Market Capitalization
Market capitalization is important to understand to determine the size of a company and highlight any traits or risk factors for investors. The market cap definition explains that it’s necessary for investors to be able to see the company size in comparison to competitors. This is especially true to measure a company’s worth on the open market and allows investors a glance into its future. The size and value can ultimately impact the risk level for investors interested in purchasing any stock and potential for return over time.
Fundamental analysis for any company is needed to find the market value. Market cap doesn’t always represent the equity value accurately. It’s not a direct reflection of what one piece of a company is worth and couldn’t determine what the sale price would be in a merger or resale transaction. Market capitalization does not measure the sales, total assets, net worth or equity value of a company and only takes into account the outstanding shares.
Levels of Market Capitalization
The division system of company’s is based on the market capitalization being broken down into different levels. By market cap definition, company levels are established by necessity and labeled as large-cap, mid-cap and small-cap. It’s important to understand what micro-cap and mega-cap companies are as well. How are they categorized in this system?
The typical market capitalization for large-caps is between $10-200 billion. These companies hold a lot of experience in an industry and are characterized as major market players. Over time, investments made with bigger companies can draw bigger rewards for investors. Large-caps are known to be consistent and provide dividend payouts. Often household name brands, these companies hold reputations for producing quality goods and services to consumers. Large-caps have proven themselves against competitors with their lengthy time in the industry.
Companies who fall into this market cap level are:
- Autozone (AZO)
- Exxon Mobil Corporation (XOM)
- General Mills (GIS)
- IBM (IBM)
- Johnson and Johnson (JNJ)
- JPMorgan Chase & Co. (JPM)
- Microsoft Corporation (MSFT)
Typically, large-caps hold the least amount of risk as a result of maintaining stable financial resources available to them. These companies will often generate more cash revenue than is needed and in turn can make return payments to their investors. This also provides a reliable safety net for any potential economic downfalls. However, these types of companies hold less potential for growth as they have already established themselves over a long period of time.
Alternatively, mega-cap companies represent those that hold a higher market capitalization of $200 billion or more. Although there are fewer companies that can be placed in this category, it is common for them to hold the largest cash reserves available to support any future economic downfalls.
Some examples of these market cap companies would are:
- Amazon (AMZN)
- Apple (APPL)
- Facebook (FB)
For mid-cap companies, market capitalization typically falls between $2-10 billion. These companies are well-established and have a reputation for operating in rapidly growing industries. Mid-caps commonly produce higher growths than large-caps. They are also considered at lesser-risk for downturns in comparison to small-caps. These types of companies provide the support needed for any future obstacles as well as the potential to beat out big competitors.
Mid-caps operate within a niche market, meaning that it fulfills a particular need or preference within an industry. As a result, there is higher-risk for a lack of growth or further struggles within the industry itself. These companies may could have been large-caps at one point in time that have ultimately suffered previous economic trouble. There is more opportunity for higher and faster gains with mid-caps, but there is also a risk for more drastic economic downfalls.
Some examples of companies at this market capitalization level are:
- Boston Beer Company Inc. (SAM)
- Cracker Barrel (CBRL)
- Dick’s Sporting Goods Inc. (DKS)
- Eagle Materials, Inc. (EXP)
- Etsy (ETSY)
- Wyndham Hotels & Resorts Inc. (WH)
Small-cap companies usually have a market capitalization between $300 million-$2 billion. Companies at this level are younger and operate in newer industries or niche markets. For this reason, it is common to find greater opportunities for growth in the industry. However, small-caps often have a higher-risk for investment due to their market value and company size. There are also fewer resources, volatile practices, and less liquid assets available to support any potential economic trouble.
Although competitive, small-caps are vulnerable and more susceptible to downturns. These companies are known to deliver above-average returns but is not true for all. The appeal stems from their growth potential. Small-caps attract seasoned investors who are understanding of stock price swings.
Examples of companies that fall into this market capitalization level are:
- Abercrombie & Fitch Co. (AF)
- Bed Bath & Beyond Inc. (BBBY)
- GoPro Inc. (GPRO)
Similarly, micro-cap companies typically hold a market capitalization between $50-300 million. It is known that theses companies are a higher-risk investment due to a lack of available assets, operations or revenue to report. Holding a smaller track record within the industry can also make an impact.
Examples of companies in this market cap would are:
- Duluth Holdings (DLTH)
- Points International (PCOM)
- BBX Capital (BBX)
Market Capitalization Matters for Future Investment
Market cap definition creates a more diversified view of a company and allows investors to see any potential stock risk. Shares can often be over-valued or under-valued as market cap is not based on any specific calculation. It may not always perceive the market value accurately. In short, market capitalization is not the only value considered by investors. Stock price allows investors to better understand the company. Increases will draw higher bids for stocks including a number of shares calculated on the impact.
Potential Impacts on Market Capitalization
There are two important risk factors for any changes in a company’s market capitalization:
- First, any significant increases or decreases in the price of stock
- Secondly, if the company issues or repurchases any shares.
Each of these factors could potentially dilute the existing value of the company.
Another notable impact on market capitalization would occur if the stock split or dividend is not altered. This means that the market cap remains consistent. A stock split is defined as being the decrease in stock price that was caused by an increase in the number of outstanding shares.
Differences Between Market Cap and Other Terminology
There are several significant differences between the market capitalization definition and any other words that are associated with market cap. Each is briefly described here:
- Enterprise Value is the measurement of a company’s total business value. This includes any debt, available assets, or cash revenue, and is used to determine what a company is priced at if bought outright.
- Float Adjusted Market Cap provides investors with an accurate view of a company’s value in stock and is calculated based on the shares available to the general public, This includes any locked-in shares.
- Free Float Market Cap represents the number of outstanding shares with the general public for trade. This excludes any locked-in shares.
- Market Value determines the value of a company by assessing metrics and multiples. Unlike market cap, this value relies on price-to-earnings, price-to-sales, and return-on-equity. Market value represents the operations, profits, debt, and market environment with the potential to vary with the market cap.
A Final Word on Market Capitalization
The market cap definition describes the formula used to find the overall market value of a company. It is an important concept to understand with many different factors involved. This type of market value is important for all companies in order to find an interested audience of investors to purchase their stocks. There are also several areas outside of the market that may impact a company’s performance, such as consumer exposure to the company’s goods or services. Market capitalization allows investors to get a better picture of the company’s size, public market value, and future potential for overall growth.