Market capitalization definition
/What is Market Capitalization?
Market capitalization is the total value of a firm’s outstanding shares, based on their current market price. All outstanding shares are included in this calculation, such as publicly-traded shares and any restricted shares held by insiders and other parties. The market capitalization concept is used to obtain a rough estimate of the value assigned to a business by the investment community.
How to Calculate Market Capitalization
Market capitalization can be calculated by multiplying the total number of shares outstanding by the current market price of the shares. For example, if a business has 10 million shares outstanding and the current market price of its stock is $15, then its market capitalization is $150 million. Any shares that have been authorized but which have not yet been issued are excluded from this calculation.
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Classifications of Market Capitalization
A publicly-held business may be classified within one of several tranches of market capitalization. A micro-cap business has a market capitalization below $250 million, while a small-cap firm has a market capitalization between $250 million and $2 billion. A mid-cap organization has a market capitalization between $2 billion and $10 billion, while a large-cap company has a market capitalization between $10 billion and $200 billion. The largest businesses, with market capitalizations exceeding $200 billion, are classified as mega-cap organizations.
These classifications are used to devise stock indexes. For example, the Russell 2000 Index is comprised of small-cap stocks, while the S&P 500 is comprised of large-cap and mega-cap stocks. These indexes are weighted by market cap, so that issuers with a high market cap will comprise more of an index than other issuers with smaller market caps.
How to Use Market Capitalization
At its most basic level, market capitalization is an indicator of the financial heft of a business. A large-cap business is likely to have substantial sales, a broad customer base, and relatively stable customer orders. This is less likely to be the case for a smaller-cap business, which probably has fewer sales, a smaller cluster of customers, and a higher degree of variability in its reported financial outcomes. In addition, large-cap entities tend to have more financial resources than smaller-cap organizations, and so are in a better position to weather the ups and downs of business cycles. Because of their greater stability, large-cap firms are more likely to pay dividends on a consistent basis over time.
Problems with Market Capitalization
There are several issues with the market capitalization concept, which are as follows:
Based on investor perceptions. The main concern with market capitalization is that it only represents the value of a business as perceived by its investors. If investors are incorrect in judging the earnings potential and future value of a business, then they bid the stock price too high or too low, resulting in a market capitalization that does not accurately reflect the prospects of a business.
Does not account for share liquidity. A key concern is the extent to which a listed company’s shares are closely held. If so, there may be few shares actively traded. When this is the case, it can be difficult for investors to buy or sell shares without significantly impacting the stock price - and therefore the market capitalization.
Not an indicator of importance. A business with a large market cap is not necessarily the largest or most important firm in its industry. It may simply be a profitable business in a market niche that investors value highly, or is perhaps involved with a new product line that investors think might eventually become quite valuable.