What is market capitalization?

Introduction

The total market capitalization of a listed company allows investors to compare the relative size of one company to another, irrespective of geography. Market capitalization measures a company's value and prospects on the open market, reflecting how much investors are willing to pay for its shares.

This article discusses what market capitalization is in detail.
 

What is market capitalization?

Understanding a company's value is significant, and often difficult to identify accurately. Market capitalization means the total number of shares outstanding multiplied by the price per share. It is a quick and easy method of estimating the value of a publicly traded company. 

After a company is listed and traded on a stock exchange, its price is determined by the supply and demand of its shares in the market.  The price rise if the stock is in high demand due to favourable factors. If the company's future growth prospects are unfavourable, sellers may lower the stock price. Market capitalization becomes a real-time estimate of a company's value.
 

How to calculate market cap?

You can calculate Market Cap using the below formula.

MC = N x P

Where MC means market capital

N stands for the number of outstanding shares.

And P is the closing price of the concerned company’s shares.

For example, if a company has 50,000 outstanding equity shares, with a closing price of INR 75 per share, now the company’s total market cap would be calculated as

MC = N x P

= 50,000 x INR 75

= INR 27,50,000 

Therefore, the total value of the company is INR 27,50,000.
 

Importance of market cap

The market cap plays a crucial role In understanding a stock’s potential. The importance of market cap includes

1.  Global metrics: Market cap is widely used to evaluate a stock. Since it is a globally accepted method, it is easier for investors to compare the stocks irrespective of their geographic or economic differences.

2.  Precise suggestions: Any suggestions on market conditions may be risky due to various factors involved in making the said suggestion. However, the market cap method is very precise in its evaluation. It fairly suggests the risks associated with a company.

3.  Affects the index: This method is also used to weigh the stocks of various companies for stock market indices. Under this method, stocks with higher market capitalization are weighted more heavily in the index.

4.  Useful for comparison: It is a convenient way for investors to compare different companies as it is a universal method used to assess the market value of any company. This comparison not only helps you understand the size of the company but also the risks involved in investing in the company.

5.  Balanced Portfolio: Investors should keep a balanced portfolio to avoid risks of greater losses. A balanced portfolio generally includes investing in some of the top companies through market capitalization and risky investments in developing companies. 

While this valuation process is convenient and widely accepted, investors should also be aware that it excludes company and other financial liabilities. Consider different types of returns such as stock splits, dividends, etc.
 

Market cap investment strategy

Given the simplicity and effectiveness of risk assessment, market capitalization can be a useful metric to decide which stocks to invest in and how to diversify a portfolio with companies of various sizes.

Large-cap companies (also known as big-cap companies) typically have a market capitalization of $10 billion or more. These companies have been around for a long time and are major players in established industries. Investing in large-cap stocks doesn't necessarily yield big returns in the short term. Regardless, these companies typically reward investors with consistent stock appreciation and dividend payments over the long run. Examples of large-cap stocks include Reliance Industries, Tata Group, etc.

Mid-cap companies typically have market caps between $2 billion and $10 billion. Medium-sized companies are established in their operating industries and are expected to grow rapidly. They are inherently more risky than large-cap companies because they are comparatively less established than the big companies, but they are attractive because of their growth potential. An example of a medium-sized company is Relaxo Footwear.

Companies with market caps between $300 million and $2 billion are typically classified as small caps. These small businesses may be young companies or serve niche markets or new industries. These companies are considered riskier investments because of their age, the markets they serve, and their size.

Smaller businesses with fewer resources are more sensitive to economic downturns. As a result, small-cap stock prices tend to be more volatile and less liquid than larger, more mature companies. Similarly, small businesses often offer greater growth opportunities than large companies. Even smaller companies are known as microcaps, which range in value from about $50 million to $300 million.
 

Top 10 Indian companies based on market cap

As on 16th September 2022, the top 10 Indian companies based on market cap are-

What are the factors which impact market caps?

There are several factors affecting the market cap including:

●  Both the demand for an institution's products or services and its ability to meet that need.
●  Exercise of warrants against company stock may reduce its value.
●  Performance and ingenuity of competing brands or institutions.
●  Company credibility and reputation.

A company's outstanding shares vary depending on share buybacks and stock buybacks. A stock split to issue new shares does not change the company's market capitalization. While various factors impact MC, it is prudent for investors to do the same.

Here is an example. Given that a company's shares are priced at Rs 100 if Ms Mehra invests Rs 10,000, he will get 100 shares of the company. The stock price will be positively affected if the company's market capitalization increases. When the stock price rises to Rs. 120, Mehra’s total investment is Rs 12,000. As a result, Ms Mehra makes a profit of Rs.2,000 with an initial investment of Rs. 10,000.

How to Calculate Short-Term Capital Gains? 

Short-term capital gains (STCG) can be calculated using the below formula.

STCG Sale value of an asset - (cost of acquisition + expenses incurred in the course of transfer/sale + cost of asset improvement)

Capital gains costs does not apply while calculating short-term capital gains on stocks. However, investors should educate themselves on the other parameters of the above formula for calculating capital gains.