Market Capitalization

Market capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share. It is an indicator of a publicly-traded company's size, risk, and returns.

To determine the size of a company, investors prefer market capitalization over total sales and total assets. This valuation tool facilitates the comparison of different firms, resulting in a balanced portfolio. Market Capitalization is popularly known as market cap.

Key Takeaways                                                               

• Market capitalization is a corporate valuation of a company in terms of market price of outstanding shares.
• Market cap is computed using the formula; Market Capitalization = Number of Outstanding Shares X Price Per Share.
• It is a parameter for determining the size of a firm based upon its market value. Investors use this tool to figure out the risk and returns associated with a company's stocks.
• This valuation tool overlooks the company's balance sheet making it unsuitable for mergers and acquisitions. In such a case, computing the enterprise value becomes essential.

Market capitalization is a broader concept that indicates investor sentiments rather than balance sheet figures. It is the determinant of a company's size evaluated as the total value of its current outstanding shares. For example, if the outstanding shares of Company X is 10,000 and the current price per share is $10, then market cap = 10,000 x $10 = $100,000.

 It is a widely accepted method among investors. Moreover, it is used to ascertain the risk involved in a company's stocks and prospective returns. Therefore, investors and portfolio managers compare the market caps of firms to create a balanced portfolio. After all, a company with a high market cap has managed to gain investors' confidence.

Other than the investors' confidence, various other factors impact the market cap of a company. These include market fluctuation, reputation, demand, competitor performance, and market buzz.

Despite being popular among investors, the market cap cannot determine a company's equity value. Tools like enterprise value figures are preferred. An enterprise value indicates a firm's actual financial position. The market cap comes with another disadvantage; stock prices are often over-valued or under-valued. This potentially leads to an inaccurate valuation.

Market cap can be differentiated based on its size. Given below are the four categories of market capitalization:

#1 - Nano Cap

These are the companies whose total shares are valued below $50 million and therefore called penny stocks. Such firms have the lowest market cap and are considered high-risk. Example: Ever-Glory International Group, Inc.

#2 - Micro Cap

The market cap of these micro-cap companies ranges between $50 million and $300 million. These stocks have low value, and their financial reports are not filed with the SEC. Thus, investors must be careful; there is little publicly available information. Example: Arch Coal, Inc.

#3 - Small Cap

The small-cap companies are rapidly growing business entities and have a market cap ranging between $300 million and $2 billion. Such stocks usually provide good returns but hold an equal risk level. Also, the share prices of small-cap funds are affordable to investors—for example, BEST Inc.

#4 - Mid Cap

Companies with a market capitalization of $2 billion to $10 billion are categorized under the mid-cap stocks. These companies provide balanced risks and return to the investors. They show a stable performance or growth in the long run—for example, Akamai Technologies Inc.

#5 - Large Cap

Large Caps are well-known and established companies with a market cap exceeding $10 billion. Expectedly, the stocks of such business entities are expensive and bear minimal risks compared to the other options. Example: Facebook, Inc.

The market capitalization of any company can be calculated using the following formula:

Market Capitalization = Number of Outstanding Shares X Price Per Share

Let's now calculate the market cap of Cisco Systems Inc.

According to Bloomberg:

• CSCO: US Price Per Share = $57.87
• Number of Shares Outstanding = $4.22 billion (4220000000)

Market Cap Formula = Number of Outstanding Shares X Price Per Share

Market Cap = 4,220,000,000 X 57.87

Market Cap = $244,211,400,000 or 244.211 billion

Some of the most prominent US companies valued based on their market capitalizations are as follows:

1. Apple Inc. (AAPL): Apple's market cap is $2.448 trillion, which is the highest worldwide; the per-share value of AAPL is $148.12. The earnings per share (EPS) in the trailing twelve months is $5.16 per share.
2. Microsoft Corp. (MSFT): Microsoft is valued at $2.253 trillion, and each unit of MSFT is worth $299.79. Also, the recent year's EPS is $8.12.
3. Alphabet Inc. (GOOGL): Ranking third with a market cap of $1.908 trillion is Alphabet, whose per-share value is $2850.89. Further, each stock made $93.42 in the last twelve months.
4. Amazon.com, Inc. (AMZN): Amazon's market cap is worth $1.747 trillion, and the price of each share is $3450, which is remarkably high. Further, each of its shares yielded $58.51 in the trailing twelve months.

Market caps do not show the actual figures. That means the market cap calculation cannot be adopted as the sole valuation measure for making a major decision. Instead, the enterprise value is a better option; it is based on a firm's takeover value. The enterprise value accounts for the total debt. The enterprise value deducts cash and cash equivalents for finding out the actual takeover value. Market cap fails to evaluate a company's worth in case of an acquisition or merger.

Both the market cap and the equity are used to analyze corporate growth; however, if the former surpasses the latter, it reflects the investors' high confidence in a company.

Mentioned below are some of the primary differences between these two measures: