What is Market Capitalization? How do you interpret it? What does it mean? And how to calculate market capitalization? Let’s find out.
What is Market Capitalization?
Market Capitalization is the total value of the Equity of the company. Put differently, it’s the total value of all of a company’s issued shares.
Contrary to popular belief, however, market capitalization is NOT the value of the company. The value of a company is based on:
- Market Value of Equity, AND
- Market Value of Debt
Thus, the market capitalization displays the market value of the company’s Equity, not the value of the company as a whole!
There is an exception, however.
If a company has no debt, then the market value of the company is equal to the market capitalization.
Value of Company = Value of Debt + Value of Equity
If a company has no debt, then the value of debt must be equal to 0. Thus, we’d have…
Value of Company = 0 + Value of Equity
And this naturally means that…
Value of Company = Value of Equity (when Debt = 0).
Incidentally, note that the equation for the Value of a Company is akin to the Accounting Equation (Assets = Liabilities + Equity)
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What Does Market Capitalization Tell You?
Okay, so you now know what is market capitalization is from a technical standpoint.
But what does Market Capitalization tell you? What does it actually mean? It can tell you 3 things, including:
- price to buy the company’s equity
- company size
- risk of the company
Let’s consider each of the three.
Price to Buy the Company’s Equity
In a nutshell, the market capitalization tells you how much you’d have to pay in order to buy the company’s Equity entirely.
And if the company has no debt, it tells you the amount you’d have to pay in order to buy the whole company.
The total market cap can also give you an idea of the size of the company. Generally speaking, we tend to categorize firms into:
- small cap
- mid cap
A small-cap company, mid-cap company, and large-cap company is one with a relatively small, medium, and large market capitalization respectively.
The specific categorization of a firm into either small, mid, or large-cap will depend on the market capitalizations of companies in the firm’s country.
For example, a company that’s considered to be a mid-cap company in one country may well be considered to be a large-cap company in another country. It’s all relative, really.
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Risk of the Company
One could argue that the market cap also sheds a little bit of light on the risk of a company. This is obviously an important consideration when evaluating a stock as a potential investment.
Generally speaking, a small-cap stock will tend to be riskier than a large-cap stock. That’s because, on average, smaller firms tend to be riskier investments than larger firms.
How to Calculate Market Capitalization
We can calculate the market capitalization by multiplying the stock price by the number of shares outstanding. In other words…
Market Capitalization = Stock Price Number of Shares outstanding
Here the Stock Price refers to the current market price of 1 share of the company. And Number of Shares outstanding reflects the total number of the company’s outstanding shares.
Let’s look at an example together.
Market Capitalization Example
Assume the price of Apple Inc. is $126.77 and the company has 16.69bn shares outstanding. What is Apple Inc’s market cap?
Answering this question is easy. You just want to be careful of the different metrics though! Remember, the number of shares outstanding in this example is in billions.
Market Cap = Stock Price Number of Shares outstanding
Plugging in our numbers, we have…
Market Cap = $126.77 $16,690,000,000
Solving for that, we have…
Market Cap = $2,115,791,300,000
That’s approximately $2.1 trillion dollars. To put that in perspective, that’s greater than the total GDP of several countries combined!
Hopefully, that makes sense, and you now know what is market capitalization, and how to calculate market capitalization.
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