What’s a company worth now? It’s a question every investor wants answered, especially before buying a stake. One method is to value a firm the way the stock market does, vis-à-vis its share price via a measure called market capitalization, commonly referred to as market cap.
Market cap represents the total dollar value of a company’s stock. It’s the hypothetical cost of the company if you were to buy up all its outstanding shares at once, at their listed market price.
A firm’s market capitalization is usually featured when you look up the ticker on Tornado or other financial sites. But if you wanted to do it yourself, the formula for figuring market cap is pretty simple: Just multiply the number of outstanding shares by the current price per share. For example, in August 2021, Uber Technologies had 1.88 billion shares outstanding and was trading at $39.25 a share. That gave it a market cap of $73.8 billion (1.88 billion x $39.25).
Because it’s based on the share price, a firm’s market cap constantly fluctuates. Major changes in market capitalization usually reflect major moves in the stock. However, sometimes the market cap shifts due to an alteration in the number of outstanding shares: if a company launches a big stock buy-back program or issues a large amount of new stock.
Market Capitalization Categories
Market cap has several important implications for investors. The first is size, as many equity benchmarks and investor strategies are based on market capitalization.
In addition to its broad market index, the S&P 500, Standard & Poor’s uses indices that represent subsegments: the S&P MidCap 400 and the S&P SmallCap 600, for example.
Small and mid-cap refer to standard market-cap categories.
- Small-cap companies have market capitalizations of $300 million to $2 billion. They’re often new — or newly public — firms, though sometimes an established-but-troubled company can have shrunk to this level, too. These are often the ones that growth-oriented investors target.
- Mid-cap companies have market capitalizations in the $2 billion to $10 billion range. They’re sort of the adolescents of the equity world: successfully grown out of the fledgling phase, but not yet mature. Value investors often eye them, as they still have potential to appreciate, but also a solid track record and earnings history.
- Large-cap companies have market capitalizations north of $10 billion. Many are venerable, profitable corporate giants — household names like Exxon Mobil, Wal-mart, General Mills, and General Electric. They may offer less volatile returns over time.
Along with these traditional categories are some trendier classifications. During the last decade’s bull market, the stupendous success of some stocks — particularly those in the tech sector — has led to companies with market caps in the trillions (think Apple and Amazon). So, some analysts now refer to mega-cap companies, which have market capitalizations over $200 billion.
On the opposite end are micro-cap companies (market capitalizations of $50 million to $300 million) and even nano-caps (market capitalizations below $50 million). Penny stocks are the main firms populating these categories. Often too small to qualify for the stock exchanges, they mostly trade over-the-counter.
In addition to indices, market-cap designations are used to manage mutual funds, with managers making their picks based on the various categories.
Significance of Market Capitalization
In addition to classifications based on size, market cap can be used in the analytical process.
In some ways, for example, a company’s market cap can speak to its risk profile as an investment. Large-cap stocks have a reputation for being solid and safe, reliable providers of income who’ll preserve your capital. Small-cap stocks tend to be more volatile, as their companies are often unproven; they can offer great growth potential, but also suffer growing pains, aka losses. And mid-cap stocks, true to their name, chart a middle course, providing some immediate income via dividends, as well as long-term appreciation.
Like other metrics, market cap can also be used as a starting point to ask further questions. Have investors given an upstart company a similar or greater market cap than an established competitor? Can the newer company grow into its valuation? Conversely, can the established company lose share — and market cap — as a result? Does entry into a new market mean the company’s market cap could be larger?
Answering these can greatly inform your process and make you a smarter investor.
Originally published on Tornado.com: What is Market Capitalization, and What Can It Reveal?
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.