Market Capitalisation

Introduction

It’s in the financial and investment world that the need to understand some key metrics makes all the difference in the quality of the decision. One of the most basic yet foundational investment analysis metrics is Market Capitalisation. Be you an old-hat investor or just a novice wanting to wade into the world of stock, understanding the concept of Market Capitalisation is paramount. Besides estimating the size and stability of the company, Market Capitalisation actually forms the crucial part of making your investment decision. In the following blog, we will have a deep dig into what market capitalization is, how one calculates it, its importance to investing, and much more. By the time you are through with this piece, you shall have a clearer understanding of that critical metric as well as an influence on making your investment choices. And if you want to be a pro at the stock market, just check out Entri’s Online Stock Market Course over here, which should upgrade your knowledge and skills to act in this financial platform with confidence.

What is Market Capitalisation?

Market Capitalisation is sometimes referred to as “market cap.” This is a measure of the company’s total value in the stock market. The aggregate market value of outstanding shares in a firm is calculated as the product of the current share price and the total number of outstanding shares. For example, if a firm has 10 million outstanding shares and each one is priced at 50.

Market Capitalisation is a moving measurement, with changes in a company’s share price. It is commonly used by investors to categorize businesses into large-cap, mid-cap, and small-cap sectors, each with characteristics and risk profiles different from the others. Understanding market cap is important because it reveals information about the size, growth potential, and level of risk for a company, all of which are important determinants when diversifying an investment portfolio.

How Is Market Capitalisation Computed?

The Market Capitalisation formula is pretty straightforward:
Market Capitalisation = Current Share Price×Total Number of Outstanding Shares

Let’s take the example and break it down.
The current market price of each share of Company XYZ is  $25. The total number of outstanding numbers of shares is 20 million. Apply the above formula,
Market Capitalisation = 25 × 20 000 000 = 500 million

Therefore, Company XYZ finds itself at a market cap of $500 million, putting it in the bracket of being mid-cap (categories are further explained below).

It must be noted that Market Capitalisation only reflects the equity value and not the debt or any liabilities of a company. Proper valuation of the company can also be done using Enterprise Value, which accounts for debt as well as cash reserves in an undertaking.

Market Capitalisation Categories

Companies are generally categorized into three main categories based on their Market Capitalisation:

• Large-Cap
  • Market Cap: $10billion+
  • Examples: Apple, Microsoft, Amazon
  • Features: These are established companies with a history of steady earnings and strong market presence. They are lower risk but may be slower growth compared to smaller companies.
• Mid-Cap
  • Market Cap: 2billionto10billion
  • Examples: Etsy, Snap Inc.
  • Features: Mid-cap companies are in the growth phase, offering a balance between stability and growth potential. They are riskier than large-cap stocks but may give higher returns.
• Small-Cap
  • Market Cap: 300millionto2 billion
  • Examples: Emerging startups and niche market players
  • Features: Small-cap companies are relatively younger and have high growth potential but have higher risk since they are volatile and easily affected by the market.
    
  • Micro-cap and mega-cap are other categories, companies whose market cap is below 300 million and above 200 billion respectively.

Why Market Capitalisation Matters

Market Capitalisation is important for investors for many reasons:

Risk Assessment
Large caps are less risky as they are stable and have been around for ages. Small caps offer higher growth but are relatively riskier.

Portfolio Diversification
The knowledge of market cap will enable you to make a diversified portfolio that balances the risk and reward. A diversified portfolio can include large caps, mid-caps, and small caps in the mix.

Investment Strategy Alignment
Your investment goals and risk tolerance must match the kind of companies you invest in. For instance, conservative investors would prefer large caps, aggressive investors would prefer small caps

Benchmarking and Performance Analysis
Market cap is used to compare companies within the same industry or sector. It also helps in benchmarking a company‘s performance against its peers.

Pros and Cons of Investing in Different Market Cap Categories

Large-Cap Companies

Large Caps

Pros:

Stability and lower volatility

Consistent dividend payments

Strong brand presence

Cons:

Slower growth than smaller companies

Limited upside

Mid Caps

Pros:

Balanced risk and reward

Higher growth than large caps

Often undervalued, can give huge gains

Cons:

More volatile than large caps

Less established than large caps

Small Caps

Pros:

Higher growth

Opportunity to invest in emerging industries

Huge returns

Cons:

Higher risk and volatility

Susceptible to market fluctuations

Limited resources compared to bigger companies

Market capitalization vs. other valuation metrics

While Market Capitalisation is widely used, take a step back and look at how it relates to other valuation metrics:

Enterprise Value (EV)

Market cap is not exactly like Enterprise Value, which also includes a company‘s debt and cash reserves for a more complete picture of the company’s total value.

Price-to-Earnings (P/E) Ratio

This measures a company’s current share price against its earnings per share (EPS), thus guiding investors on whether a stock is overpriced or undervalued.

P/B Ratio

This ratio compares the market value of a company to its book value, thus showing whether a stock is trading at a premium or discount.

Where those metrics add several layers of depth, Market Capitalisation is basic in determining how big a firm is and, by extension, its market capitalization.

The Impact of Market Capitalisation on Stock Performance

Market Capitalization can significantly determine the performance of a stock on several levels as follows:

Liquidity
Large-cap firms are relatively easier to buy and sell without triggering a drastic decline in the value of the firm’s shares

Volatility

Small-cap stocks are usually more volatile, meaning more significant price swings than big-cap stocks.

Interest from Investors

The large-cap company usually attracts more institutional investors, thus making it less volatile and of low volatility.

Index Inclusion

Being able to be included in major indices, such as the S&P 500, is common for companies with bigger market caps. This leads to more recognition and investment.

Conclusion

Market Capitalisation is one of the most fundamental metrics that an investor should be aware of. Insights are drawn into the size, stability, and growth of a company. Informed investment decisions make it easy for you to invest in large-cap giants or small-cap startups with high growth rates.  Informed investment decisions make it easy for you to invest in large-cap giants or small-cap startups with high growth rates.

And if you want to dive deeper into the world of investing and master all the intricacies in the stock market, do check out our Online Stock Market Course here at Entri. The course will be designed so that it covers complete knowledge and skills required for navigation in financial markets with confidence. From key metrics like Market Capitalisation to winning investment strategies, Entri’s course has got you covered.

Investment is a journey in itself, where the more knowledge you gain will enable you to make the correct financial decisions. So, step into the light today and make yourself a capable investor with expert guidance from Entri.