- Market capitalisation (“market cap”) is the total value of all a company’s stock: the number of outstanding shares by the share price.
- Stocks are often categorised by the size of their market capitalisation: large-cap, mid-cap, small-cap, or micro-cap.
- An indicator of financial strength, market capitalisation suggests how risky a stock is and what kinds of returns it might offer.
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A big part of the investing game is trying to figure out what a company is worth. If you can measure a company’s value, you’ll be in a better position to know whether you want to commit your hard-earned capital to its stock.
Of course, a variety of ways exist to evaluate public companies and their stock. One of the most common is by market capitalisation, or “market cap” for short.
A company’s market capitalisation is what it would cost you if you were to buy up all of its outstanding shares at the current share price. It is a way of sizing up a company by the value that investors put on it.
Here’s how it works, and why it matters to your investing strategy.
What is market capitalisation?
Market capitalisation is essentially the total value of a company’s outstanding stock.
Expressed in dollar figures (or whatever the local currency), it’s made up of two factors: the number of a company’s outstanding shares, and the price of each share.
A company’s market cap is often included in its online stock listing or company profile. But figuring it out isn’t all that hard. To calculate the market capitalisation you simply multiply the number of shares outstanding by the price per share.
For example, a company that has 50 million outstanding shares and a share price of $US10 has a market capitalisation of $US500 million.
We could use Apple (AAPL) as a real-life example. As of December 2020, Apple has about 17 billion shares outstanding. The price of Apple’s stock is at $US113.85 per share. To calculate the market capitalisation, we multiply the two and get about $US1,921 billion.
What makes market capitalisation change?
Since it depends directly on a company’s stock price, market capitalisation changes every day. As the price of a company’s stock goes up, so does its market capitalisation, and vice versa.
Changes in the number of outstanding shares also influences market capitalisation. Companies sometimes issue additional shares to raise capital or buy back shares. Assuming a constant share price, issuing shares would increase market capitalisation and buying them back would decrease it.
Market capitalisation categories and investment strategies
You’ll often hear companies classified in terms of their market capitalisation. Based on dollar size, these classifications can also help investors pick the right stocks for their investment goals and risk tolerance.
The most common market cap categories for stocks are:
- Micro-cap and nano-cap
Although no official or legal designations exist, there are generally agreed-upon boundaries for each market cap category.
Large-caps have a market capitalisation of over $US10 billion. They are are very large companies, usually those with a long history and a household name: Apple, Visa, Johnson & Johnson, Walmart.
They are typically less risky investments, given that they’re backed by years of stable earnings and stock price performance. However, as mature corporations, they also usually do not grow very quickly.
For investors, that means large-cap stocks may bring steady â€” but not massive â€” returns. Most blue-chip stocks are large-caps.
Mid-caps have a market capitalisation between $US2 and $US10 billion. They are usually sizable, well-established companies. Some may be familiar names, like American Eagle Outfitters, Lending Tree, and TripAdvisor; others might be less well-known, but are respected and fast-rising in their field, like Peloton or Diamondback Energy.
As their name suggests, mid-caps occupy a middle ground for investors: They may be riskier than large-caps, but are still relatively safe (certainly more so than the small-caps, from whose ranks they often spring). Their stock can be more volatile than large-caps’, but it also may also have more potential for appreciation, as many of these companies are still actively growing.
Small-cap companies are riskier still. But with a market capitalisation between $US300 million and $US2 billion, they can provide opportunities for major appreciation; in fact, these firms are often the darlings of growth-oriented investors. Getting in on the ground floor of a successful small-cap company can be very lucrative â€” if you guess right. But it may take time for it to pay off, and unlike the large- or mid-caps, it probably won’t be providing much in terms of dividends or other returns in the meanwhile.
Small-cap companies include Neophotonics Corp., Unisys Corp., and Purple Innovation.
Micro-cap and nano-cap valuation
Smaller companies can be divided even further. Micro-caps are typically companies that have a market capitalisation between $US50 million and $US300 million. Nano-caps are those with a market capitalisation below $US50 million.
Why is market capitalisation important?
Market cap is an important concept because it allows investors to understand the size of a company and how much its worth on the market. Since companies of different market-cap sizes vary in terms of their growth potential, income payments, and risk, spreading your investments among them is one way to balance your portfolio between appreciation and income, between conservative and aggressive.
Often, investors focus on a particular market cap segment. Some may choose to stick with the big, stable, large-caps â€” especially if they want to preserve their capital or derive income from their investments. Others may be attracted to the more volatile â€” and exciting â€” small-caps, especially if they have a long time horizon to weather volatility or like aggressive growth stocks.
Cutting across industries and industrial sectors, each market cap group encompasses a big variety of companies and stocks. Still, analysts do note common tendencies and characteristics among stocks of similar market caps.
For example, Robert R. Johnson, Professor of Finance at Creighton University, notes that small-caps may be more volatile than mid- and large-caps â€” but they tend to perform better.
“From 1926 to 2019, large-cap stocks have provided average returns of 10.2% annually; small-cap stocks over the same time period provided annual returns of 11.9%,” he says.
It doesn’t sound like much in percentage terms. However, “over many years, that difference is enormous: one dollar invested in large-caps at the end of 1925, with dividends reinvested, would have grown to $US9,243.90. That same dollar invested in small-caps would have grown to $US39,380.90.,” Johnson notes.
“The bottom line is that small-cap stocks provide higher returns, on average â€” but that comes at the cost of greater risk.”
Market capitalisation vs. market value
You’ll sometimes hear “market capitalisation” used interchangeably with “market value.” But they don’t mean the same thing. Whereas market capitalisation is a single, easy-to-calculate figure, market value is a more complex, amorphous characteristic that we try to estimate in a number of ways.
As Ryan Maxwell, COO at FirstRate Data, notes, “market value” is a generic term that refers to the value of an investment (such as a company’s stock) as determined by a market (usually, the stock market). Reflecting investor sentiment, it might take into account company assets, fundamentals, and other factors.
For example, Maxwell says, a company’s enterprise value is another specific measure of a company’s market value, one that considers its debt as well as its stock.
Alongside market capitalisation and enterprise valuation, investors will often use ratios such as price-to-earnings ratio, price-to-sales ratios, and return on equity to compare values between companies.
“Everyone is working to measure a company’s true market value,”Asher Rogovy, Chief Investment Officer at Magnifina, says. “Whoever understands the true value can profit by trading mispriced stocks. Market capitalisation represents how investors, on average, estimate true market value. It’s one indicator of market value and a great starting point for analysis.”
The financial takeaway
Market capitalisation is a way to measure what a company’s worth is. Essentially the collective price of all of a company’s outstanding shares, market capitalisation tells us about the value that investors put on a company’s stock.
And that tells us, indirectly, about what we can expect from the company in terms of returns.
Companies with lower market capitalisation values may be riskier but can pay off big. Companies with greater market capitalizations probably will preserve your funds, but may not offer massive gains.
If you’re a more conservative investor, you may lean towards large-caps. And if you’re looking for more of a gamble, small-caps might be for you. If you want a balance in your portfolio â€” appreciation plus income â€” the mid-caps may be the way to go.
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