Market Cap: What is Market Cap in Stocks?
Companies have monetary worth, which we can determine through valuation or market capitalization. Learning what the market cap is in stocks will guide your trading decisions on how profitable a stock can be. Hence, market capitalization is a vital metric to evaluate stocks
The market cap provides perspective on company size, investment risk, growth prospects, and market perception. Categorizing stocks as large, mid, or small caps based on market cap ranges helps compare firms within industries.
While an insightful starting point in the analysis, market cap requires supplementation by financial ratios and qualitative factors for a holistic assessment. This article explores the market cap’s definition, significance, limitations, and role in constructing diversified portfolios.
What is Market Capitalization?
The market cap represents the total market value of a company’s outstanding shares. This single number provides an “at-a-glance” measure of company size for easy comparison. It sums up the market’s consensus valuation based on supply and demand.
Large-cap stocks (over $10 billion market cap) are established players perceived as lower risk. Small caps ($300M-$2B) have higher growth potential but more volatility. Midcaps fall between $2B-$10B.
The Role of Market Cap in Stock Valuation
For investors, market cap indicates a stock’s relative size, stability, and growth opportunities. It provides context for comparing valuations between companies.
It helps determine if a stock is potentially overvalued or undervalued. Stocks with high market caps suggest a stock price exceeding its actual worth. Low market caps suggest unrealized value. Comparing market cap to financial metrics like revenue offers clues.
A company’s market cap also indicates trading liquidity. Large-cap stocks are highly liquid, while small-cap stocks can be harder to buy/sell.
Calculation of Market Capitalization
If you have been following through with this article, then at some point, you must have wondered how to calculate the market cap. To calculate market capitalization:
- Identify the current share price
- Determine the total shares outstanding
- Multiply share price by shares outstanding (this is the market cap formula)
For example, Company A:
- Current Share Price: $20
- Shares Outstanding: 10 million
- Market Cap = $20 x 10 million = $200 million
Use updated share prices to reflect real-time valuation. The market cap changes as stock prices fluctuate.
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Large Cap Stocks
Large-cap stocks, with market caps exceeding $10 billion, represent industry titans known for their stability and dominance. Despite their size, they continually innovate to maintain their competitive edge. Core characteristics include transparency, reliable dividends, stability, brand recognition, and innovation potential. Investors employ strategies such as value, dividend, growth, indexing, active management, and risk management. Well-known examples include Apple, Microsoft, and Amazon.
Mid-cap stocks, ranging from $2 billion to $10 billion in market capitalization, offer a balance between stability and growth potential. They often dominate niche markets and combine solid growth with less volatility than small caps. Investors must balance risk and reward, targeting mature companies with strong growth prospects. Mid-caps serve as a supplement to large-cap holdings in diversified portfolios, offering stability and above-average growth.
Small Cap Stocks
Small-cap stocks, with market caps from $250 million to $2 billion, hail from younger, niche companies offering high growth potential but also higher volatility. Due diligence is crucial due to lower liquidity and transparency. Strategies include analyzing growth trajectories and diversifying across companies and industries. Despite the higher risk, small caps offer substantial growth opportunities and can deliver exponential returns to savvy investors.
Market Cap and Share Price Dynamics
Market cap and share dynamics: do they share something in common? How do they influence each other? Let’s explore these in this section, as we set you up for better trades.
Market Cap and Stock Price
The market cap is the total market value of the company at any given time. Consequently, the share price itself is determined by forces of supply and demand in the stock market, along with investor sentiment. When demand is high, share prices rise. When sentiment turns negative, prices can fall.
So, while the market cap depends on the share price, the share price moves independently based on investor behavior. The share price will increase if more investors want to buy the stock. This then lifts the market cap.
So, when analyzing companies, look at both metrics. But remember – the share price leads while the market cap follows.
Stock Splits and Reverse Splits
When companies announce stock splits, investors often see significant price fluctuations. But are dramatic changes in share prices just smoke and mirrors?
Stock splits can appear to increase or decrease value overnight radically. However, the underlying company fundamentals remain unchanged.
For example, in a 2-for-1 stock split, an investor who owned 1 share at $100 would see the price drop to $50, even though the company’s total value is the same.
Splits simply divide the same market capitalization into more slices (stock split) or fewer slices (reverse split). The optics of lower or higher prices deceive many into believing value itself is changing.
In reality, splits are cosmetic adjustments to share structure. The size of the slices changes, but the fundamental value pie stays fixed.
Share Buybacks and Market Cap
Companies repurchase their shares, hoping to boost stock prices. The logic seems simple – reducing shares outstanding should increase earnings per share (EPS). Higher EPS leads to a higher valuation multiple and share price, lifting market capitalization.
But this thinking is overly simplistic. Buybacks only temporarily increase EPS on paper. They do not change company fundamentals or profitability.
Buybacks may temporarily boost share prices. But their impact depends on the context and diminishes over time. Improving core operations, not financial engineering, is what grows market value.
In the end, buybacks are no guarantee of increasing market capitalization. Their influence is circumstantial and limited. The company may still fail without fundamental performance to back it up.
What is Market Cap? Conclusion
Market capitalization is a useful starting point for assessing company size and potential but has limitations as a sole evaluation metric. While market cap offers a quick perspective on risk, stability, and growth prospects, holistic analysis requires incorporating ratios, fundamentals, and qualitative factors.
When building portfolios, blending large, mid, and small-cap stocks can balance stability and growth opportunities. However, caps should align with individual goals and constraints.
Learning about market cap isn't the final goal, but putting the knowledge to work is. Opening an account on eToro provides a platform to put market cap knowledge into action when investing in stocks across all caps.
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What does market cap tell you?Market cap, or market capitalization, tells you the total dollar value of a company's outstanding shares of stock. It is calculated by multiplying the number of shares by the current share price. A market cap measures a company's size, performance, and risk.
Is it good to have a higher market cap?A higher market cap generally means a company is more established, profitable, and stable. It also indicates that the company has a lower risk of failure or bankruptcy. However, a higher market cap does not necessarily mean a company is overvalued or that its stock price will increase.
What is a good market cap range?There is no definitive answer to what a good market cap range is, as different investors may have different preferences and goals. Small caps range from $300 to $2 billion, while mid caps range from $2 billion to $10 billion. Large caps are above $10 billion.
How does market cap affect a stock?The market cap affects a stock in several ways. These include its liquidity, volatility, growth potential, and dividends.
What happens when the market cap goes up?When the market cap goes up, it means that the value of a company has increased. That can occur because of increased earnings, a new product launch, acquisitions, and positive media coverage. Other reasons include stock splits, buyback programs, increased dividend yields, etc.
View all posts by Jeremiah Awogboro
Jeremiah Awogboro is an experienced content writer with over 8 years of experience. He has a qualified MBChB degree and a keen interest in the stock market and the finance industry. His background in the industry has provided him with valuable experience in this field. Awogboro is dedicated to assisting and reaching out to as many people as possible through his writing. In his spare time, he enjoys music, football, traveling, and reading.Scroll Up