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One of the most common measures of a company's size is its market capitalization. Unlike some of the other measures of a company's size such as revenues, market capitalization is not reported in one of the company's financial statements. It is calculated based on the number of shares of common stock outstanding and its market price per share.
In this publication, we're going to discuss perhaps the most common term used to describe the size of a company: market capitalization. We'll start that discussion with a brief summary of the measure as well as a definition of the term. Next, we'll talk about how market capitalization is used by stock analysts to categorize companies. Then we'll finish this topic with an example calculation.
Market Capitalization
Also known as market cap, the term market capitalization is used to describe the total value the stock market has assigned to all of the shares of a company's common stock. It's an important measure to stock market analysts because the concept of market capitalization provides a simple way to separate companies into various sizes.
Mutual funds often use terms such as small cap, mid cap, and large cap, to provide prospective clients with a feel for the types of companies the fund will hold in their portfolio. Market capitalization is also a commonly applied filter when using a stock screener. Unfortunately, there isn't a standard definition for market cap break points. For example, we could have:
- Large Cap: companies with a market capitalization that is in excess of $10 billion
- Mid Cap: companies with a market capitalization that is between $1 and $10 billion
- Small Cap: companies with a market capitalization that is under $1 billion
While some financial institutions might include more granular categories such as:
- Mega Cap: companies with a market capitalization that is in excess of $100 billion
- Micro Cap: companies with a market capitalization that is between $10 and $100 million
- Nano Cap: companies with a market capitalization that is under $10 million
Generally, smaller companies provide investors with greater growth opportunities, while larger companies provide lower risk in terms of price volatility and returns on investment.
Market Capitalization Formula
The market analyst only needs to know two things about a company in order to calculate its market capitalization: the number of common shares outstanding, and the current market price of those shares of stock. The mathematical equation for market cap is as follows:
Market Capitalization = Shares Outstanding x Price per Share
where:
- Shares Outstanding = the total shares of common stock issued
- Price per Share = the current price per share of common stock
From the above equation, it's clear that market capitalization measures the entire value the stock market places on a given company. Now that we've provided a definition of the term, explained how market capitalization is used by analysts, and provided the mathematical formula, let's finish this topic with an example.
Market Capitalization: Example Calculation
In this first example, Company XYZ has issued 235 million shares of common stock. The current market price per share of stock is $25. From the above equation, we know:
Market Capitalization = 235 million shares x $25 per share
Market Capitalization = $5.875 billion
One common misconception is that price per share is a good indicator of the size of a company. That is to say, a company with a price per share of $100 is larger than a company with a price per share of only $25. We can use our market capitalization formula to dispel that myth.
In our second example, Company ABC has issued 10 million shares of common stock. The current market price per share is $100. From the above equation, we know:
Market Capitalization = 10 million shares x $100 per share
Market Capitalization = $1.0 billion
Even though Company ABC's stock is selling for four times that of Company XYZ, we also know that Company XYZ has nearly 24 times more shares of common stock in the marketplace. Since market capitalization is a function of both price per share and the number of shares outstanding, we found that Company XYZ was the larger of the two.
About the Author - Understanding Market Capitalization
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