In the financial world, terms like market cap, large cap, small cap etc. are frequently used and a clear understanding of these is essential for analyzing the market and devising appropriate investment strategies.
Concept - Market Capitalization
Market cap or market capitalization is a figure used to determine the size of a company. Market cap is nothing but the value of a publicly traded company’s outstanding shares. This is obtained by multiplying the total number of outstanding shares by the closing market price of a share.
Remember, this is different from company’s Capitalization, which is found on company’s financial statement representing all shareholders’ equity plus company’s long-term debts.
Calculation
The formula used to calculate market cap is:
MC = P x n, where MC represents the market cap value, P represents the current price of each share of the company and n represents the number of shares outstanding.
Let us assume that ABC Company has 1 million outstanding shares and the closing price of each share is INR 20. This implies, ABC company’s market cap is currently (INR 20 x 1 million) = INR 20 million.
It is easy to understand from this formula that the market cap value of a company is highly sensitive to the closing share price. If it fluctuates, the market cap figure will show different values.
Types
Depending on this value, companies are commonly classified in various categories:
| Category | Market Cap Value | Example | Risk Level |
| Mega Cap | $200 billion or higher | Exxon | Most stable |
| Large Cap | $10 billion to $200 billion | Blue chip companies | Stable and secure |
| Mid Cap | $2 billion to $10 billion | Growth stock companies | Riskier than the aforementioned categories |
| Small Cap | $300 million to $2 billion | Dave & Buster’s Entertainment | Greater capital gain, greater risk |
| Micro Cap | $50 million to $300 million | Penny stocks | High possibility of risk and return |
| Nano Cap | Lower than $50 million | OTC stocks | High risks, little gain |
This categorization is a broad one and is subject to change depending upon inflation, overall market valuation and the country in concern.
Importance
Stock prices often give misleading information on company’s size. That’s why it is better to consider a company’s market capitalization value to determine its size, growth and risk. Market cap indicates worthiness a company on the open market and market expectations on company’s future.
If an investor knows how large, mid and small market cap companies behave it is easier for him to diversify and to maintain a mixed portfolio. This figure is also of value to the investors investing in mutual funds.
Indian Scenario
According to World Bank report, towards the end of 2014, India’s market capitalization stood at $1,558,299,690,000. It is believed that the governmental change at the center in 2014 was the main reason to bring India among the 10 biggest stock markets of the world.
Conclusion
Market Capitalization represents only the equity value of a company and not the value at which the company can be purchased in a merger. A more broad-based measure is Enterprise Value which takes notes of preferred shares, outstanding debts etc.
Market capitalization does help to provide the basis for assessment of any company’s financial well being.This is because generally the risk averse investors tend to select Large cap or mega cap for investing their money , as it would exhibit stable performance.