Defining Market Capitalization for Beginners in Finance
What is market capitalization?
Market capitalization represents the total market value of a company’s outstanding stock shares. It is used to measure and classify the size of a company. These classifications, and what they signify, are useful for financial professionals because they help in assessing the size and risk of a company before investing, or before providing financial advice to other investors. Market value is calculated by multiplying the stock price by the total number of outstanding shares. This figure shows, theoretically, what it would cost to purchase the company; though a company’s market cap and value are not necessarily equal. The market value figure can be used as a starting point to make an overall evaluation of a company.
What are the categories of market capitalization?
Categories are used to classify companies based on their market capitalization. These are useful for investors when comparing companies of similar sizes, and when determining which different stocks to invest in to achieve diversified portfolios. The following three categories are the most common classifications used to rank companies that have stocks.
Large Cap/Mega Cap
Large cap companies have a market capitalization of $10 billion or more. The companies in this category are generally well established, well known, and tend to dominate their industries. Their stocks, often referred to as “blue chips,” are structured to consistently pay increasing dividends over time, as opposed to providing investors with large returns in a short period. There is another classification of companies that are greater than large caps. These are called “mega caps.” They represent companies with a market cap of $200 billion or more. Mega caps are usually iconic industries leaders, such as Apple or General Electric.
The market capitalization range for mid cap companies is between $2 and $10 billion. These companies are successful and established within their industry. They represent a less risky investment than small cap companies, though their potential for growth is not as high. While mid cap companies are not leaders in their industries, they are often in the process of expanding, with the goal of growing into a large cap stock. Although mid cap companies represent middle-of-the-road risk and growth potential, financial advisors often recommend building a diversified portfolio that includes mid cap stocks.
Small cap companies have a market capitalization of less than $2 billion. These are generally young companies that offer substantial growth potential and serve smaller or new industries. Small cap stocks also tend to be more volatile than other stock classifications, with the greatest potential risk for failure. They are also more susceptible to economic downturns and recessions than large and mid cap stocks.
In addition to small caps, there are other classifications for even smaller stocks. Micro caps signify companies with a market capitalization between $50 million to $300 million, while nano caps represent companies below $50 million in market capitalization. Micro and nano cap stocks have potential for extreme growth. They also carry the greatest possible risk.
What is the difference between the market capitalization
and the market value of a company?
The price of a company is different from its value. This distinction may be difficult to determine, though it is essential for finance professionals to understand. A company’s price is represented by its stock price, which is used to determine an organization’s market capitalization. The market value of a company requires a more involved calculation. Determining value takes into account factors such as the company’s price-to-earning ratio, price-to-sales, stockholder equity, long-term growth potential, assets, liabilities, and debt.
Those who are new to the world of finance are confronted with many terms. “Market capitalization” is one of them. It is a fundamental concept for every financial professional to understand, especially those hired by investors to determine which stocks will build a solid portfolio and yield the greatest returns. Understanding market capitalization— how to calculate it and use it—is a key component of making strategic investment decisions. It is also necessary for career success in the demanding and exciting financial investment industry.
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