Market cap refers to the total value of a company’s shares on the market, as well as the market’s perception of its future prospects. Here’s a quick breakdown of how to calculate it – and why it’s worth paying attention to.
What is Market Capitalisation?
Market capitalisation, or ‘market cap’, is the total market value of a publicly-traded company’s outstanding shares (i.e. the stocks currently held by all its shareholders).
It is calculated by multiplying the total volume of a company’s outstanding shares by the current market price of one share. For example, if a company has 5 million shares and each share is valued at USD 50, its market cap would be USD 250 million.
Why is Market Cap Important?
Contrary to popular opinion, market capitalisation is not an accurate representation of a company’s ‘true value’ or enterprise worth. It only reflects the amount of money the market is currently willing to pay to own a piece of that company.
Investors use market cap to determine a company’s size relative to other companies listed on each stock exchange, which acts as an indicator of the risk of investing in its shares. For this reason, investors tend to split stocks into 3 categories: large-cap (USD 10 billion and above), mid-cap (USD 2 to 10 billion) and small-cap (USD 300 million to 2 billion).
Generally speaking, investments in large-cap stocks are regarded as more stable than investments in mid-cap or small-cap stocks as the latter have yet to ‘prove themselves’ in the face of competition, uncertainty or downturns. That said, larger companies have less room to grow, meaning lower potential returns. A diversified portfolio, therefore, includes a range of large-cap, mid-cap and small-cap stocks.