Market Cap: In-Depth Guide of Stock Market Capitalization Analysis

What Does Market Cap Mean?

“Market capitalization refers to the total dollar market value of a company’s outstanding shares. Commonly referred to as ‘market cap,’ it is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.”

What is a Stock’s Market Value?

An important aspect of determining a stock’s worth is looking at its market value. The market value ​ is the price that an asset would command. ​ Figuring out the general market value of stocks and some other financial instruments like futures is pretty simple, since the market rates are extremely easy to find.

A company’s true market value requires more than just the market cap. For the most accurate snapshot, you need to consider things like the P/E Ratio (Price to Earnings Ratio), the return on equity, ​ ​ and the EPS (Earnings Per Share) of the company in question. ​ ​

Market Cap vs. Market Value

Both market cap and market value can be used to review the value of a company. They sound similar, and sometimes people use the terms interchangeably.

The market cap is a metric that is based on the stock price. To determine a company’s market cap, all you have to do is multiply the current share price by the number of shares outstanding.

With that in mind, it’s kind of understandable why the term market value is used interchangeably with market cap. However, considering the copany’s value frequently goes beyond just considering the market cap.

Market Value vs. Stock Price

It’s a common misconception that the price per share is a strong indicator of a company’s value. Yes, it is an indicator, but it can’t be considered without backing it up with other information and metrics.

Market capitalization can be a metric that bridges this gap. By calculating the market cap, you can ​ gain a better idea of the actual value of the company on an overarching scale. This can give you a ​ much better clue as to the value of a company.

It should also be noted that the market value can differ from the so-called book value. If the stock is under the book value, for instance, it might be considered undervalued. This means it’s trading at a very big discount.

Of course, it doesn’t always work in a black-and-white way. For instance, if a stock is trading over the book value, it doesn’t necessarily mean the stock is overvalued. It could just mean that a catalyst of some sort has increased the supply and demand. This could be temporary.

How To Calculate Market Capitalization

Market Cap Formula

Let’s put that into a practical example. Say Company X has 1 million shares, and each share costs $4 each. This means its market cap is $40 million.

Easy, right? Determining the market cap is easy, but understanding what it means is where it gets a little bit more involved.

The number you calculate with the market cap formula tells you the size of the company in question, and the amount of money that would be tied up if it were to be sold right this minute. In that way, it’s considered one of the key indicators of the market value.

Of course, without context these figures don’t have too much meaning. For instance, a company with a $50 million market cap might seem really impressive, until you consider it against a $10 billion market cap.

Market Capitalization Ratio

The book value can be determined by looking at the business’s historical cost in the market.

According to Investopedia, this can be figured out through this calculation:

Book-to-market ratio = common shareholders’ equity / market capitalization

By calculating this ratio, you can gain a better idea of the market value of a company as opposed to its actual worth.

Example of Market Capitalization Analysis for Traders

Here’s an example. Let’s say that one company has stock shares available for $200, and the other has shares for $30. It is tempting to think that the company with the higher priced shares is bigger and better, and therefore a better investment.

Hold up. But if the first company has a market cap of $200 billion and the second one had a market cap of $225 billion, all of a sudden that comparison doesn’t seem quite as cut and dry.

If you had only looked at the stock price, you wouldn’t be looking at the big picture. The market cap can level the playing field and help smooth out edges like the size, the outstanding shares, and other considerations.

What Could Impact a Company’s Stock Market Capitalization?

A company’s market cap is by no means a one-and-done sort of deal. What can affect or change a market cap? Two key things:

● A significant change in stock price. If there’s some major event that affects the stock ​ price in a big way, it can affect the market cap. Yes, of course any shift in the stock price will

have some effect, but to really impact the market cap in a noticeable way, it would have to

be bigger.

● The company issues or repurchases shares. A big change to the amount of shares ​ available can affect the market cap. This means if there is a stock split or some other big ​ ​ change in the amount of shares, it can have an effect.

How Does Market Capitalization Affect Stock Value?

In a nutshell, the market cap can give you an indication about the value of a stock, but it shouldn’t be used as your sole indicator. Why? For these reasons:

● Market cap doesn’t tell the whole story. While the market cap can help you gain some

important basic information about a company, it doesn’t tell you the entire story. You still

have to do your fundamental research.

● Stock shares aren’t always valued properly. While it might seem like the market cap will tell

you what the business is worth, it’s not quite as easy as that. Because stock shares can be

over- or under-valued, this can skew the figures. Supply and demand is what rules stock

price, and it can shift based on what people are willing to pay.

● Market cap doesn’t tell you the total value of the business. If a company has a market

capitalization of $2 billion, it doesn’t necessarily mean that it would command that price if

someone else made an offer to buy it. There are many more factors to consider in such a case. To really get a realistic idea, you’d want to figure out the enterprise value — but that’s a subject for another post!

Different Types of Market Capitalization

Mega Cap

These are massive companies with a market cap of $200 billion and above. To attain this status, you must be an industry leader. A heavyweight commodity company like Google, or big guys like

ExxonMobil fall into this highest echelon of market capitalization.

Big/Large Cap

For instance, the Walt Disney Company would be considered a large-cap company. Companies like

Walmart or General Electric also fall into this mix. Along with the mega caps, they are considered blue-chip stocks. They’re generally stable, secure, and often deliver long-term, slow-but-steady value.

The idea here is that the share values increase steadily, so you can steadily mount returns and dividends.

Mid Cap

While buying a stock from a mid-cap company might not have the same risk level as penny stocks, ​ ​ they can carry more risk than trading the stock of a large-cap company. The appeal lies in the fact that they aren’t too scary-risky, yet might offer a quicker rate of return.

As a reference, an example of a mid-cap company would be Prestige Brands Holdings. This is a pharmaceutical company that sells a variety of recognizable over-the-counter medications including oral care products, sleep aids, pediatric care items, and digestive aids.

Small Cap

These are companies that fall between $300 million to $2 billion with the market cap formula. They are often new companies or companies within up-and-coming industries. They might have gone public pretty quickly to raise money. It can be hard to find big financial histories of these companies for analysis. They sometimes provide a quicker rate of return, but possibly with higher risk.

Micro Cap

This is where many penny stocks live. Some have a high chance of delivering profits, if they realize their potential — but since that’s something most of us will never know, they usually carry a high level of risk.

Nano Cap

These are companies that fall below $50 million. These are, by far, typically the riskiest caps to invest in, and you’ll usually find them on pink sheets.

Is bigger better? When it comes to market cap, size matters. But is bigger better? Not necessarily.

Yes, bigger companies can offer some benefits. For example, they’re a often more proven, so the risk can generally be lower. These aren’t the types of companies that are likely to crash and burn.