Market capitalization – what is it?
Market capitalization, also used in the enterprise value method of company valuation, is the total value of outstanding shares of a given company.
This parameter can be used to determine the size of a company. Potential investors want to know it because, while it’s reasonably easy to calculate, it provides a lot of information about other characteristics of the enterprise such as the level of risk.
Using market capitalization also lets investors diversify their assets by including large-cap, mid-cap, and small-cap companies in their portfolio.
This division is based on the value of the market cap. Large-cap companies have a market cap of around $10 billion and more. Usually, this term refers to companies which have been operating for a long time. They are popular, stable and well-established on the market, so investing in them is considered safe – even if short-term returns aren’t spectacular, investors can expect continuing growth of share value.
Mid-cap companies are these with a market cap between $2 and $10 billion. They are not so well-established as large-cap companies, so there’s more risk connected with investing in them; however, they are supposed to grow rapidly in the nearest future.
The last group, small-cap companies, includes ones with a market cap lower than $2 billion. Usually, they are young or operate in niche markets. The risk here is the highest among these three groups, but they might give investors the highest return on investment.
Market capitalization formula
The calculation of market capitalization is pretty straightforward. Its formula consists of two elements:
- Current price of a single share;
- Number of outstanding shares of a company (the ones currently owned by the shareholders).
The only thing you need to do is multiply the price of one single share by the number of all outstanding shares a company has. The formula is as follows:
Market capitalization = price of share * number of outstanding shares
How to calculate the market capitalization?
Let’s analyze an example of a company that has been on the market for a few years now. We’re aiming to determine whether it’s a large-cap, medium-cap, or a small-cap company.
- Find out how many outstanding shares the company has. Let’s assume it’s 10 million shares.
- Determine the current price of one share. We can say the company sells them at a price of 100$ per share.
- Multiply the number of shares by the price, according to the market capitalization formula:
10M * $100 = $100M = $1B
- The market capitalization is equal to $1 billion. We can conclude that this company is still a small-cap one but probably has some potential to become a medium-cap business in the foreseeable future.