Understanding Market Capitalization

Market capitalization, commonly referred to as market cap, is a fundamental concept in the stock market. It provides a quick and standardized way to determine a company’s size and value. Market cap is calculated by multiplying a company’s total number of outstanding shares by the current market price of one share. This metric helps investors assess the relative size of companies and is often used to categorize them into different groups, such as large-cap, mid-cap, and small-cap stocks.

How to Calculate Market Capitalization

To understand market cap, let’s break down its calculation. Suppose a company has 10 million shares outstanding, and each share is priced at $50. The market cap would be:

  • Market Cap = Number of Shares * Price per Share
  • Market Cap = 10,000,000 * 50 = $500,000,000
  • So, the market capitalization of this company is $500 million.

Categories of Market Capitalization

Companies are typically grouped into categories based on their market cap:

  1. Large-Cap: These companies have a market cap of $10 billion or more. They are often well-established companies with a significant market presence. Examples include Apple, Microsoft, and Amazon. Large-cap stocks are usually considered stable and are less likely to experience extreme price fluctuations. Another term you may hear to describe them is “Blue chip companies.”
  2. Mid-Cap: Companies with a market cap between $2 billion and $10 billion fall into this category. They often represent companies that are more established than small-caps but still have potential for growth. Mid-cap stocks can offer a balance of growth and stability.
  3. Small-Cap: These are companies with a market cap of less than $2 billion. Small-cap stocks are typically younger, smaller companies with higher growth potential but also higher risk. They can be more volatile and are often more sensitive to market conditions. Another term you may hear to describe them is “low float.”

Market Capitalization vs. Enterprise Value

While market cap is a useful measure of a company’s size, it doesn’t account for a company’s debt or cash reserves. This is where enterprise value (EV) comes into play. EV is calculated as:

  • Enterprise Value = Market Cap + Total Debt – Cash and Cash Equivalents

Enterprise value provides a more comprehensive view of a company’s total value, considering its debt and cash. Investors often use EV to compare companies with different capital structures more accurately. This is not so much a metric that traders care about.

Factors Affecting Market Capitalization

Because its a two part equation, only two things move a company’s market cap:

  1. Stock Price Movements: Market cap changes with the stock price. If a company’s share price increases or decreases, its market cap will also rise or fall. For example on May 22, 2024 Nvidia reported earnings and the stock gapped up $113.7. The net effect for their market cap was an increase of $268 billion.
  2. Share Issuance or Buybacks: If a company issues more shares, its market cap increases. Conversely, if a company buys back its shares, the market cap decreases as the number of outstanding shares reduces.

Conclusion

Market capitalization is a standardized metric for understanding a company’s size and value in the stock market. Most traders who want to follow stocks that respect technical analysis will find that mega-cap tech companies work best. They are highly liquid and stable companies that rarely make irrational moves intraday. Traders who wish to trade highly risky stocks that are more likely to make outsized moves on any given day likely prefer to trade low-float small-cap stocks.