One of the most common measures of a company's size is its market capitalization. Unlike revenues, market capitalization is not reported in one of the company's financial statements. It's calculated based on the number of common shares outstanding and their market price per share.
In this article, we're going to discuss perhaps the most common term used to describe the size of a company: market capitalization. We'll start that discussion with a brief summary of the measure as well as a definition of the term. Next, we'll talk about how market capitalization is used by stock analysts to categorize companies. Then we'll finish this topic with an example calculation.
Also known as market cap, the term market capitalization is used to describe the total value the stock market has assigned to all of the shares of a company's common stock. It's an important measure to investors and analysts because the concept provides a simple way to separate companies into various sizes.
Mutual funds often use terms such as small, mid, and large cap, to provide prospective clients with a feel for the types of companies the fund will hold in their portfolio. Market capitalization is also a commonly applied filter when using a stock screener. Unfortunately, there isn't a standard definition for market cap break points. For example, there can be:
While some financial institutions might include more granular categories such as:
Generally, smaller companies provide investors with greater growth opportunities, while larger companies provide lower risk in terms of price volatility and returns on investment.
The market analyst only needs to know two facts about a company in order to calculate its market capitalization: the number of common shares outstanding, and the current market price of those shares. The mathematical equation for market cap is as follows:
Market Capitalization = Shares Outstanding x Price per Share
From the above equation, it's clear this measures the entire value the stock market places on a given company. At this point, example calculations will be useful in demonstrating the concepts learned so far.
Company XYZ has issued 235 million shares of common stock. The current market price per share is $25. From the above equation, we know their market capitalization is:
= 235 million shares x $25 per share
= $5.875 billion
One common misconception is that price per share is a good indicator of the size of a company. That is to say, a company with a price per share of $100 is larger than one with a price per share of only $25. We can use our market capitalization formula to dispel that myth.
In our second example, Company ABC has issued 10 million shares of common stock. The current market price per share is $100. From the above equation, we know their market capitalization is:
= 10 million shares x $100 per share
= $1.0 billion
Even though Company ABC's stock is selling for four times that of Company XYZ, we also know that Company XYZ has nearly 24 times more shares of common stock in the marketplace. Since market capitalization is a function of both price per share and the number of shares outstanding, we found that Company XYZ was the larger of the two.
About the Author - Understanding Market Capitalization