Market Cap: What is Market Cap in Stocks?

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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

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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FAQs

References

• https://www.statista.com/statistics/263264/top-companies-in-the-world-by-market-capitalization/# 
• https://www.slickcharts.com/sp500 
• https://knowledge.wharton.upenn.edu/article/making-sense-of-stock-buybacks/#: 
• https://fortune.com/recommends/investing/what-is-time-horizon/ 
• https://www.economist.com/finance-and-economics/2022/06/30/what-past-market-crashes-have-looked-like