What is market cap and why does it matter?

Market capitalization is an indication of how much a company is worth according to the stock market. It is calculated by multiplying the number of outstanding shares a company has by the individual share price.

Connor Campbell Published on 17 August 2021.
What is market cap and why does it matter?

Market cap, or market capitalization, is a way of assessing how much a company is worth according to the stock market.

It is essentially an indication of how much it would cost if you were to buy all the shares available.

Read on to learn more about the meaning of market capitalization and how to calculate it.

» MORE: Investing basics and how to get started

What does market cap mean?

Market cap is essentially how much a company is worth or valued at. There are two elements that make up a company’s market capitalization: outstanding shares and share price.

Since it is the figure it would technically ‘cost’ to buy all the shares and therefore ‘own’ the company, the basic calculation for market cap is to multiply the number of shares outstanding by the share price.

If you actually were to buy a company outright, however, things get more complicated. It would require you to factor in a company’s total debt, cash and cash equivalents, as well as market cap, in order to calculate its enterprise value (EV).

What are outstanding shares?

Outstanding shares are the total number of shares in a company currently held by shareholders.

This will include closely held stock, restricted stock and floating stock, but not treasury stock (which is stock held in reserve by the company itself).

If a company issues 100 million shares, and all 100 million are held by shareholders, then the number of outstanding shares a company has is 100 million. The more shares a company has, the smaller the ownership stake will be for each share.

This number can rise, if a company issues more shares to raise capital, or can fall, in the case of a share buyback programme, for example.

When the number of outstanding shares in a company rises or falls, it tends to have an impact on the company’s share price.

What is share price?

This is maybe the aspect of investing people are most familiar with.

A company’s share price – or stock price – is the price it costs to buy one share in that company at any given moment.

Share prices are not fixed and will move up or down based on a number of market factors, including the financial performance of the company, political headlines, and wider economic data.

Sometimes, share price is more a measure of public perception than the value of a company based on its total assets and is often an indicator of how much faith the market has in a company’s future potential.

Market capitalization formula

The market capitalization formula is actually quite simple:

(Number of outstanding shares in a company) x (current share price)

Say, for example, Company A has 20 million shares outstanding and a current share price of £100. The market cap calculation would then be:

20 million x £100 = £2 billion

Therefore Company A’s market cap is £2 billion.

The important thing to remember is that since the share price of a company can and does rise and fall from one day to the next, even from one moment to the next, market cap follows suit and is therefore a fluid figure.

What is float-adjusted market capitalization?

There is an alternative method of calculating market cap called free-float, or float-adjusted, market capitalization.

Instead of using outstanding shares, which includes ‘locked in’ shares held by institutions and governments, this calculation uses floating stock.

Floating stock is the number of shares in a company freely available for investors to trade.

A lot of major stock indices use float-adjusted market capitalization, including the Dow Jones Industrial Average and FTSE 100 Index.

Why does market cap matter?

One of the ways you can use market capitalization to evaluate your investments is by looking at how companies are divided up by market cap, as it generally gives you an indication of how large a company is.

Traditionally there were three divisions: large-cap, mid-cap and small-cap. However, the concepts of micro-cap and mega-cap have grown in use over time.

Like share price, market capitalization is very fluid, meaning a company is not a fixed member of these groups.

These definitions are also not hard and fast rules, but broad categories that can expand and contract depending on the criteria. This includes the fact the parameters of these categories are usually expressed in USD, leading to some slight differences in definition on a regional basis.

Nevertheless, they are useful as a starting point for considering the benefits and disadvantages of companies of different sizes, and can help you put together a well-rounded and diversified investment portfolio.

» MORE: What you need to know about buying shares

Large-cap

Typically, a large-cap stock will be a company with a market capitalization of more than $10 billion.

These kinds of companies will normally be deemed stalwarts of the economy and constituents of the more high-profile stock indices, such as the FTSE 100 and Dow Jones.

Mid-cap

The definition of a mid-cap stock can range from anything between a market cap of $2 billion and $10 billion.

Small-cap

Normally, those stocks with a market capitalization of between $300 million and $2 billion would be classed as small-caps.

Micro- and mega-cap

Though used less frequently, micro- and mega-cap are terms used to cover those companies that sit either side of the large-mid-small spectrum.

Micro-caps normally have a market cap of between $50 million and $300 million and tend to be very new to the stock market.

Mega-cap, on the other hand, has a looser definition, but covers those behemoths with market caps of anywhere between $200 billion and more than $1 trillion.

This includes the largest companies in the world by market cap, a title that is regularly given to the likes of Apple and Microsoft, both of whom, at points, have had market caps higher than $2 trillion.

» MORE: Tips to consider before investing

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

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About the author:

Connor is a writer and spokesperson for NerdWallet. Previously at Spreadex, his market commentary has been quoted in the likes of the BBC, The Guardian, Evening Standard, Reuters and The Independent. Read more

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