In a stock market, not all stocks are the same. Therefore if you want to invest in stocks, you may want to select the right stocks that align with your investment goals. In choosing the best stocks to buy, investors typically look at certain metrics to better understand a stock. Market capitalisation is one of those metrics investors commonly use to evaluate stocks.
What is market capitalisation?
Market capitalisation (also known as market cap) is the total market value of all outstanding shares of a company’s stock. Therefore, market capitalisation shows us the total value that investors have placed on a company’s shares.
How do you calculate market capitalization?
To calculate a company’s market capitalisation, you multiply the number of the company’s outstanding shares by its current stock price.
- A company with 50 million outstanding shares trading at $20 each would have a market cap of $1 billion.
- A company with 10 million shares trading at $200 each would have a market cap of $2 billion.
In the stock market, market capitalisation can be used to categorise companies by size, as part of stock investing due diligence. There is no single rule in categorising companies by market cap, so the list can be long or short. However, here are the common market cap tiers:
- Large-cap companies: These are typically large corporations with a market cap of $10 billion or more. Most large-cap companies have been around for many years, run strong brands, and operate in well-established industries where they are the major players. You can call them the blue chip-companies. Large-cap companies tend to be slow-growth businesses that may not deliver huge returns over a short period. However, they generally produce solid returns over the long term and are deemed lower-risk investments.
- Mid-cap companies: These are businesses with a market capitalisation anywhere between $2 billion and $10 billion. Mid-cap companies are established businesses that have not yet realized their full growth potential. Therefore, mid-cap companies tend to have faster growth than large-cap companies. However, they are deemed higher-risk investments than large-cap companies.
- Small-cap companies: These are businesses with market capitalisations between $300 million and $2 billion. They are typically young companies with great growth potential. Small-cap stocks are deemed riskier investments than mid-cap and large-cap stocks, in part because they tend to have limited resources. Consequently, they are more vulnerable to economic downturns.
Applying market capitalisation in risk assessment
Market capitalisation can be a helpful metric when assessing the risks in potential stock investments. Other market capitalisation tiers you may come across are mega-cap and micro-cap, which sit at the extreme ends of the tiers we have examined above.
What causes changes in market capitalisation?
A company’s market capitalisation can change from time to time. A variety of factors can alter a company’s market cap. Here are two main factors that could cause a company’s market capitalisation to change.
- A significant rise or drop in a company’s stock price. A company’s stock price can register a big move upward after the company reports strong earnings or releases a new product that investors believe will be a huge success. But the stock price can also plunge if the company posts surprisingly weak earnings results or gets hit with a potentially costly lawsuit. Since market cap is tied to stock price, it would change accordingly.
- An increase or decrease in the number of a company’s outstanding shares. A company’s outstanding shares would increase if the company sells more shares to raise more capital to fund its expansion. Outstanding shares would decrease if the company repurchases some of its shares, a process that puts money back in the pockets of shareholders. Once again, since market capitalisation is tied to outstanding share count, it would change accordingly.
Although a stock split or reverse-split would change a company’s outstanding share count, they have no effect on market capitalisation.
Market capitalisation helps investors understand more about a company than they would if they just looked at the company’s stock price alone. Use it when assessing long-term stocks.