What is market capitalization? How to evaluate market capitalization, and how to analyze market cap?
In this article, we start with the explanation of market capitalization, we go through an example of calculating market capitalization, discuss grouping companies by the size of market cap, dive into the meaning of companies having a low market cap or high market cap, and discuss how market capitalization relates to takeover bids.
Market Capitalization Definition
Market capitalization (or in short: market cap) is the market value of a company based on the entire importance of all its publicly traded outstanding shares. This indicates that you can’t calculate market capitalization for companies that are not publicly listed.
The formula for calculating market cap is clearly to take the
Several excellent shares (X) share prices.
Example of Calculating Market Capitalization
Let’s take the example of calculating market capitalization. We will calculate the market cap of Microsoft on November 13, 2018. The number of outstanding shares can be found in the latest quarterly earnings release, more specifically at the bottom of the income statement that is included in the press release.
A company discloses its number of outstanding shares to give background information on the Earnings per Share calculation. In the case of Microsoft, the weighted average number of outstanding shares for the three months that ended September 30, 2018, was close to 7.7 billion shares.
The second data point we need is the share price. The closing share price for Microsoft on November 13, 2018, was almost $107 per share. To calculate market capitalization, all we need to do is to multiply the number of outstanding shares by the share price.
In the case of Microsoft, on November 13, 2018, the market cap was $821 billion, which on that date makes it one of the three biggest companies in the world in terms of market capitalization.
There’s an easy way to check whether our calculation of market capitalization is correct: go to any website or search engine that provides share price information, type in the company name or ticker symbol, and scroll down below the graph. Market capitalization tends to be mentioned right there. $821 billion of market capitalization, just like the outcome of our formula.
Grouping Companies by Market Gap
Which categories of market capitalization exist?
There is no standard or official definition of market cap categories, but an often-used classification is for small-cap companies to have a market capitalization between $300 million and $2 billion, mid-cap or medium cap companies to have a market capitalization between $2 billion and $10 billion, and large-cap companies to have a market capitalization bigger than $10 billion.
Is there anything bigger than a large-cap company? Yes, mega-cap companies, with a market capitalization of more than $100 billion. Is there anything smaller than a small-cap company? Yes, a micro-cap company with a market capitalization between $50 million and $300 million, and even smaller than that, nano-cap companies with a market capitalization below $50 million.
What Does Low or High Market Cap Mean
That is an interesting question, but potentially not the best question to ask, because the growth or decline in market capitalization might be just as important as the absolute market capitalization of a company at a point in time.
Here’s a graph of the development of Microsoft’s market capitalization over more than a decade. In November 2018, with the benefit of hindsight, I sure wish I could travel back in time 3 or 5 years to buy Microsoft shares at $40. Will I still feel the same in November 2019, November 2020, or November 2021? Time will tell whether the market cap continues to go up, or will move down!
Hindsight is a great thing, and your guess of future market cap is as good (or as poor) as mine.
If we do want to ruminate or assume on low market cap versus high market cap, then here are some potential reasons for companies to have a poor versus a high market cap.
|Low Market Cap Businesses||High Market Cap Businesses|
A poor market capitalization could be an indication of investor pessimism about the company’s future, and a big market capitalization an indication of positiveness.
The share price of an organization, and therefore its market capitalization is too important dependent on goals for the future. A low market cap organization might have low expansion (or even declining) projections for future revenue, income, and cash flow.
A high market cap organization may have bigger growth projections. Also, intentions for the future, a share price (and therefore the market capitalization) relies on sentiment: is there low or high passion about a business’s technique, technology, and management?
Lastly, the growth phase that a company and its business units are in, could also be significant. A low market cap company could be a company in the embryonic or early growth stage with the best yet to come, or a company in decline with its best days behind it, or a business that will forever stay small.
A high market company could be a company that has entered a specific level of maturity (a proven track record) in some business units but has continued exciting new growth opportunities.
Diversify Industries and Cap Sizes
Keep those thoughts in mind when making investment decisions, and just like diversifying your portfolio across industries could help you balance risk and opportunities, diversifying between holding shares in small-cap and large-cap companies could improve diversification as well.
Market Cap and Takeover Bids
To close off: what is the relationship between market capitalization and takeover bids. First observation: micro-cap, small-cap, and medium-cap companies tend to be the ones that are most often targeted with a takeover bid. They are sizable enough to contribute to the acquiring company’s inorganic growth.
but not necessarily so large that they could bring down the whole of the newly combined company in case the merger does not go well. Remember that market capitalization (or: market cap) is the recent market value of an organization established on the entire price of all its publicly traded outstanding shares.
Read Also: INDIAN ECONOMY
In the case of a takeover bid, there tends to be an M&A premium of around 20 to 30% on top of the current share price. After all, you want to give the current shareholders a good reason to sell their shares to you and support the takeover.
I hope you enjoyed this explanation and discussion of market capitalization. Thank you.