Market Capitalization

The total dollar market value of a company's outstanding shares of stock.

The total dollar market value of a company's outstanding shares of stock is referred to as market capitalization. According to the investment community, the size of a corporation is determined by this number rather than revenue or total assets. 

The market cap is used in acquisitions to assess whether a takeover candidate offers a good value to the acquirer. It can be difficult to rapidly and precisely determine a company's worth, but it is essential information. 

After a firm goes public and begins trading on the exchange, the price of its shares in the market is determined by supply and demand. 

The price will rise if there is a significant demand for its shares due to advantageous reasons. Conversely, sellers of the stock may lower its price if the company's future growth outlook is poor. The company's value is then estimated in real-time using the market cap.

This approach often reflects a company's stage of development. For example, investments in large-cap stock are often considered more cautious than those in small-cap or mid-cap stock, probably because they carry less risk but have a slower potential for growth.

On the other hand, midcap equities often fall between giant corporations and small caps on the risk/return continuum.

Midcap companies may be working to boost their overall competitiveness and market share. However, this development phase may determine if a company realizes its full potential. 

Midcap equities sometimes lie between giant corporations and small caps on the risk/return spectrum. Midcaps may offer more potential for growth. As a result, they can have more room to expand than huge caps.

Due to their relative lack of resources, small-cap companies' stock prices may be more erratic during business or economic depression. They may also be more subject to emerging markets' fierce rivalry and unpredictability.

On the other hand, long-term investors dealing with volatile short-term stock price movements can discover that small-cap stocks have much room to expand.

A method of assessing an investment's success is comparing a stock's returns to an index of other investments with a similar risk profile. Like equities, indices exist in a range of sizes and shapes.

The most widely used metric for large-cap stocks is the Standard & Poor's (S&P) 500. In addition, the S&P MidCap 400 and S&P SmallCap 600 indices, as their names imply respectively, reflect midcap and small-cap equities. Another well-known index for small-cap companies is the Russell 2000.

How to calculate Market Cap

It is a quick and easy approach to determining a publicly traded company's value by extrapolating the market worth. In this case, multiply the share price by the number of shares outstanding.

The formula for the market cap is as follows:

Market Cap = Current Share Price * Number of Current Shares Outstanding 

For instance, a company with 20 million shares trading at $100 each would be valued at $2 billion on the market. On the other hand, a second company with 10,000 shares outstanding and a $1,000 share price would only have a $10 million market capitalization.

The first stage in calculating a company's market cap is an initial public offering (IPO) (IPO).

A company that wants to go public engages an investment bank to use valuation procedures to assess the company's value and determine the number of shares that will be issued to the public and at what price. This is done before the IPO.

For instance, if a company sets its IPO value to be $10 million, it can play around with the number of shares and its price. 

If the total number of shares issued is $10 million, the share price would be $1. However, if the share amount is 5 million, the share price would be $2 each.

The initial market valuation would be $10 million in both scenarios.

What is a diluted market cap?

The number of shares still in circulation might cause a security's market capitalization to fluctuate over time. This is particularly common in cryptocurrency, as new tokens or coins are routinely created or issued.

A different market cap method can determine the potential market cap should all authorized shares or tokens be issued and still be worth the current trading price. 

This is because new offerings theoretically dilute the value of existing coins, tokens, or shares. The formula for the diluted market cap is as follows:

Diluted Market Cap= Current Share Price* Total Number of Shares Authorized 

Consider Bitcoin, which in mid-August 2022 was trading at about $24,000 per coin.

There are currently 19.1 million Bitcoins in circulation. However, there are 21 million possible Bitcoins that can be created. So, the formulas used to determine Bitcoin's market cap are:

  • Market Cap = $24,000 * 19.1 million = $458,000,000
  • Market Cap Diluted = $24,000 * 21,000,000 = $504,000,000

A diluted market cap is a tool analysts use to understand how an asset, token, or coin price may vary in the future. For example, imagine that all 21 million Bitcoin will be created tomorrow. 

The price would decrease to about $21,828 ($458.4 million / 21 million) to maintain the same market cap of $458.4 million. 

Thus, organizations with vast inventories of unissued securities or coins are more likely to see price declines if investors want to maintain a company's market cap regardless of the number of outstanding tokens.

Market Cap and strategy

The market cap can be a useful statistic in deciding which stocks an investor is interested in and how to diversify his or her portfolio with companies of various sizes due to its simplicity and efficacy for risk assessment. 

The different market caps of companies have different strategies that correspond to their size. Some strategies for companies with large, mid, and small market caps are listed below:

1. Market capitalizations of $10 billion or more are usual for large-cap (also known as big-cap) corporations. These businesses have typically existed for a long time and are significant participants in long-standing sectors. 

Although investing in large-cap corporations may not immediately yield high returns, these businesses often pay out dividends over the long term and raise the value of their shares, rewarding investors. 

Apple Inc., Microsoft Corp., and Alphabet Inc., the parent company of Google, are some examples of large-cap corporations. However, keep in mind that this is a constantly evolving sample.

2. Market capitalizations for mid-cap corporations typically range from $2 billion to $10 billion. Mid-cap corporations are well-established businesses that compete in a sector with high growth prospects. Mid-cap businesses are currently growing. 

They are riskier than large-cap companies because they are less established, but their growth potential makes them appealing. Eagle Materials Inc. is one instance of a mid-cap business (EXP).

3. Small-cap firms are often defined as those with a market valuation of $300 million to $2 billion. These tiny businesses might be recent start-ups or cater to specific markets and emerging industries. 

Due to their size, age, and target markets, these businesses are regarded as higher-risk investments.

Smaller businesses are more vulnerable to economic downturns since they have fewer resources.

Thus, small-cap share prices have higher volatility and lower liquidity than those of more established corporations. 

At the same time, small businesses frequently offer more room for growth than large corporations. Micro-cap firms are smaller businesses with values between $50 million and $300 million.

Large-cap, mid-cap, and small-cap stocks have traditionally led the market in various eras because each stock can be affected differently by the market or economic events.

As a result, many investors diversify their portfolios by holding securities with different market sizes. As a result, when large caps are losing value, small or midcap stocks may increase in value and help to make up for any losses.

Therefore, building a portfolio with the correct mix of small-, mid-, and large-cap companies is essential.

A diversified portfolio with a variety of market caps may help achieve financial objectives by reducing investment risk in any one sector.

What would impact a company's market cap? 

Several variables may impact the market capitalization of a corporation. It could be affected by the following:

  1. Significant changes in the shares' value (either up or down).
  2. Adjustments to the number of shares issued.

Any warrant exercise on a company's stock will increase the number of outstanding shares, lowering the stock's value already in existence. 

Because the warrants are typically exercised below the share's market price, this could affect the company's market capitalization.

However, a stock split or dividend often has little impact on market valuation. The stock price will decline following a split because there are more outstanding shares. For instance, the share price will be cut in half in a 2-for-1 split. 

As a result, a company's market cap stays the same while its shares are in circulation and stock prices fluctuate. The same holds for dividends. A company's price typically decreases if it declares a dividend, increasing the number of shares held.

You must assess your financial objectives, risk tolerance, and time horizon to create a portfolio that includes the right proportion of small-, mid-, and large-cap companies.

To build a portfolio with the appropriate mix of small-, mid-, and large-cap companies, you must consider your financial goals, risk tolerance, and time horizon.

A diversified portfolio with a variety of market caps may help you achieve your long-term financial goals by reducing investing risk in any one sector.

However, it is important to note that a large market cap suggests that the business is in an established position.

Larger companies may have less room for growth than start-ups, but they might obtain financing quickly, provide a more consistent cash flow, and gain from their brand name.

Even though this is true for all companies, bigger companies tend to be less dangerous than smaller ones.

Having a huge market capitalization has benefits and limitations. On the one hand, larger businesses could sell corporate bonds to banks to obtain better financing terms.

These businesses may also gain from scale-related competitive advantages like increased brand recognition or cost savings.

However, large firms may only have a few opportunities for expansion, which could eventually slow down their growth rates.

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Researched and authored by Anja Corbolokovic | Linkedin 

Reviewed and edited by Parul GuptaLinkedIn

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