Market capitalisation, or market cap for short, is the total dollar value of a publicly-traded company’s outstanding stocks. When companies are given the label “most valuable in the world”, it is in terms of market cap. It is a metric used to relatively tell a company’s size, which can be useful when creating investment plans and strategies.
To calculate a company’s market cap, you simply multiply the total number of outstanding shares by the current market price of a stock. For example, if company XYZ has 50 million shares outstanding and shares are currently trading at $10 per share, its market cap is $500 million.
Market cap = current price per share x number of share outstanding
A common misconception is that companies with higher share prices are worth more. In comparison to the above example, say company XYZ has 10 million shares outstanding and shares are trading at $20 per share, its market cap is then $200 million. So, although shares are double the price, the company’s valuation is lower.
When a private company offers an initial public offering (IPO), this is when its first market cap value is established. At this stage, typically investment banks will derive a company’s value and set the number of shares to be offered and the price per share. After the company starts trading on the exchange, its market cap fluctuates depending on share prices, dictated by supply and demand, and changes in the number of shares outstanding.
Companies are typically grouped in one of the below categories based on their market caps:
Since market cap is dependent on current share prices and the number of shares outstanding, any factor impacting either can, in turn, affect a company’s market cap. Stock prices constantly fluctuate depending on the supply and demand in the stock market. Therefore, market caps are not static.
In regards to the number of shares outstanding, a company’s market cap will change if it issues new shares or buys some of them back. The same goes for exercising warrants on a stock since in this case new shares are issued.
Although stock splits will impact both share prices and the number of outstanding shares, this typically will not affect a company’s market cap. For example, a 2-for-1 stock split will double the number of shares outstanding but will cut share prices in half. Therefore, the effect is offset.
Knowing a company’s market cap can be useful when making an investment strategy and investment decisions. Your investment goals, risk tolerance, and time horizon should be specific to your personal and financial situation. For example, if you have a longer investment horizon and are willing to take on more risk in the hope of higher returns, you could invest in more small or mid-cap companies.
Market cap can also help in diversifying your portfolio. Having a variety of companies in your portfolio with different market caps can help spread risk. But market cap is just one aspect to take into account when trying to achieve a diversified portfolio. For example, you can also invest in companies in different sectors or countries, or invest in other financial products, such as ETFs and bonds instead of exclusively investing in stocks.
It is important to note that although market cap can provide a general idea of a company’s risk level and size, it is not the only indicator. For example, shares can be over or undervalued by the market, meaning the price investors are willing to pay can be more or less than the true value the company is worth. Therefore, it is advisable to do further research into a company’s financials to determine the health of the company before investing.
The information in this article is not written for advisory purposes, nor does it intend to recommend any investments. Investing involves risks. You can lose (a part of) your deposit. We advise you to only invest in financial products that match your knowledge and experience.