Market Capitalization: What It Means for Investors

What Is Market Capitalization?

Market capitalization, or "market cap," represents the total dollar market value of a company's outstanding shares of stock. Investors use this figure to determine a company's size instead of sales or total asset value. In an acquisition, the market cap helps determine whether a takeover candidate represents a good value for the acquirer.

Key Takeaways

• Market capitalization shows how much a company is worth as determined by the total market value of all outstanding shares.
• To calculate a company's market cap, multiply the number of outstanding shares by the current market value of one share.
• Market cap is used to determine a company's size, and then compare the company's financial performance to other companies of various sizes.

How to Calculate Market Cap

Market capitalization estimates a company's value by extrapolating what the market thinks it is worth for publicly traded companies and multiplying the share price by the number of available shares. After a company goes public and begins trading on an exchange, its share price is determined by supply and demand. As market prices move, the market cap becomes a real-time estimate of the company's value. The formula for market capitalization is:

Market Cap = Current Share Price * Total Number of Shares Outstanding

A company with 20 million shares selling at $100 a share has a market cap of $2 billion. A second company with a share price of $1,000 but only 10,000 shares outstanding, has a market cap of $10 million.

An initial public offering (IPO) helps determine a company's first market capitalization. An investment bank employs valuation techniques to derive a company's value and determine how many shares will be offered to the public and at what price.

Market Cap and Company Size

Large-cap companies typically have a market capitalization of $10 billion or more and represent major players in well-established industries and sectors.1 These companies generally reward investors with a consistent increase in share value and dividend payments. Examples of large-cap companies include Apple Inc., Microsoft Corp., and Alphabet Inc.

Mid-cap companies generally have a market capitalization between $2 billion and $10 billion.2 Mid-cap companies operate in an industry expected to experience rapid growth. Mid-cap companies are in the process of expanding and carry an inherently higher risk than large-cap companies. One example of a mid-cap company is Eagle Materials Inc. (EXP).3

Companies with a market capitalization between $250 million and $2 billion are commonly classified as small-cap companies. These small companies may serve niche markets and new industries. These companies are considered higher-risk investments due to their age, the markets they serve, and their size. Small-cap share prices may be more volatile but provide greater growth opportunities than large caps. Smaller companies, known as micro-cap, have values below $250 million.2

Market Cap and Digital Currency

Because new digital currency offerings theoretically thin the value of existing coins, tokens, or shares, a different market cap formula can be used to calculate the market cap for all authorized shares or tokens. Analysts use diluted market cap to understand potential changes to a security, token, or coin's price.4 The diluted market cap formula is:

Diluted Market Cap = Current Share Price * Total Number of Shares Authorized

Assume Bitcoin trades at $24,000 per coin, with 19.1 million Bitcoin already issued. The total number of potential Bitcoin that may be minted is 21 million. Therefore, Bitcoin's market cap calculations are:

Market Cap = $24,000 * 19.1 million = $458.4 billion

Diluted Market Cap = $24,000 * 21 million = $504 billion

Misconceptions About Market Caps

Although it is used to describe a company, market capitalization does not measure the equity value of a company. Only a thorough analysis of a company's fundamentals can do that. Shares are often over- or undervalued by the market, meaning the market price determines only how much the market is willing to pay for its shares.

The market cap does not determine the amount the company would cost to acquire in a merger transaction. A better method of calculating the price of acquiring a business outright is the enterprise value.

What Factors Alter a Company's Market Cap?

Two factors can alter a company's market cap: significant changes in the price of a stock or when a company issues or repurchases shares. An investor who exercises a large amount of warrants can also increase the number of shares on the market and negatively affect shareholders in a process known as dilution.

What Does a High Market Cap Tell You?

A high market cap signifies that the company has a larger presence in the market. Larger companies may have less growth potential than start-up firms, but established companies may be able to secure financing cheaper, have a more consistent stream of revenue, and capitalize on brand recognition.

Does Market Cap Affect Stock Price?

Market cap does not affect stock price; rather, market cap is calculated by analyzing the stock price and number of shares issued. Although a blue-chip stock may perform better because of organizational efficiency and greater market presence, having a higher market cap does not directly impact stock prices.

What Is the Importance of Market Cap?

Market cap is often used as a baseline for analysis as all other financial metrics must be viewed through this lens. For example, a company could have had twice as much revenue as any other company in the industry. However, if the company's market cap is four times as large, the argument could be made that the company is underperforming.

The Bottom Line

Market cap can be a valuable tool for investors watching stocks and evaluating potential investments. Market capitalization is a quick and easy method for estimating a company's value by extrapolating what the market thinks it is worth for publicly traded companies. In an acquisition, the market cap helps determine whether a takeover candidate represents a good value to the acquirer.