MARKET CAPITALIZATION
WHAT IS MARKET CAPITALIZATION?
Market capitalization is also referred to as a market cap which is the total market value of all the outstanding shares and is calculated by multiplying the outstanding shares with the current market price, investors take help of this ratio to determine the size of the company rather than using total assets or total sales. For instance, if the outstanding shares of company ABC is 1,00,000 and the current price per share is Rs. 10, the market cap will be 1,00,00 X Rs. 10 = 10,00,000.
EXPLANATION OF THE FORMULA
The formula for the market cap is
Market cap = Outstanding shares X Market Price of each share
There is always confusion between the equity value of the company and the market cap. But the market cap is not the equity value as it is based on market price, whereas, equity value is calculated on the book value basis. Most investors get occupying stocks of companies depending on the market cap. But there is a flaw that needs to be understood.
Market cap can not and should not be the sole domain of the valuation of an entity. That means the market cap does not equal the ‘takeover value’ of the firm. So it is flawed. What is significant for investors to consider is to understand enterprise value when they want to invest in the said company.
WHY DOES MARKET CAP MATTER?
Market cap reflects the theoretical cost of buying all of an entity’s shares but generally is not what the company could be purchased for in a normal merge transaction. To evaluate and estimate what it will cost for an investor to buy a company outright, the calculation of enterprise value is more appropriate. Thus market cap is a better and ideal measure of size than worth. That is, the market cap is not the same as market value which can usually only be assigned when the company is actually sold.
MARKET CAP CATEGORIES
1. Micro-Cap:
They are the penny stocks that are young when compared to others. The micro-cap companies’ potential for decline and growth is of identical nature. They are not considered secure and safe investments and hence require a lot of research before investing.
2. Small-cap:
These are high risk and high return stocks, as the companies in this category are in the growth stage. A large number of companies in the Indian stock exchange belong to the small-cap category.
3. Mid-Cap:
In general, mid-cap stocks are more volatile and dynamic than large-cap stocks and have more growth potential, and are growth-oriented stocks.
4. Large Cap:
This category has companies which are in the industry for a long time and have been expanded to a large level. Some of the examples would be Reliance, Tata, Adani among others.
ARE MARKET VALUE AND MARKET CAP THE SAME?
As the name suggests, these two are clearly different concepts. Market cap is simply determined by multiplying the outstanding shares with the current market price of the shares.
Market value is determined with the help of various phenomena such as Price to sales ratio, price to earnings ratio, free cash flows, the future value of dividends among others.
FACTORS AFFECTING THE MARKET CAP OF THE COMPANY
Following factors affect the market cap of an entity:
- Company-specific news
- Company’s fundamental parameters
- Demand and Supply of a particular stock
- Economic environment and other factors such as geopolitics and macroeconomics.
- Performance of competitors