You measure various valuation metrics like PE ratio, PB ratio, and EPS before investing in any stock, but there is one more very famous measure – market capitalization. It tells you the current value of a company based on its traded number of shares. So, let’s unfold what is market capitalization, its formula, its types, and its relevance.
What is Market Capitalization?
What is market capitalization? Market capitalization meaning is covered in its name. In the “market” part, the current market price of a stock is taken, and “capitalization” covers how much capital it has in terms of shares. In short, the market cap tells you the total market value of a company.
It helps in estimating a company’s current valuation based on what the market thinks its worth should be as it is dependent on the current share price. Once a company goes public and is listed on the stock exchange, its share price is determined by the classic economics rule of supply and demand.
Market cap has a positive correlation with the current share price of a company. When the price of the stock rises, its market cap also rises or vice versa. Eventually, the company’s market cap changes the whole day when the shares are traded in the market.
How to Calculate Market Capitalization?
WHY SMC
- 20 Lac+ unique clients
- 33+ Years of Serving
- Advance Technical Analysis
- Free Demat Account
The market capitalization is calculated by multiplying the per-share price of a company by the number of outstanding shares traded in the market. Outstanding shares mean the total number of shares held by all the shareholders, including institutional investors’ shares or any restricted shares.
Market Capitalization Formula = Current Market Price of a Stock X Total Number of Outstanding Shares of a Company
For example, if company Z’s stock price is ₹500 and it has 10 lakh outstanding shares, then its market cap would be ₹500 X 10 lakh = ₹50 crores.
3 Types of Market Capitalization
This metric helps in bracketing the companies based on their market capitalization. There are three types of market capitalization India which is defined by SEBI.
1. Large-cap Companies
According to SEBI’s classification norm, the companies that are ranked from 1 to 100 position in terms of full market capitalization are called large-cap companies. Generally, large-cap companies are the ones that have a market cap of more than ₹20,000 crores. Some of the top large-cap companies in India are Reliance Industries, Tata Consultancy Services and HDFC Bank.
These companies hold a significant position in the market and are generally safeguarded from sharp market swings. Their financial position is so strong that they can face any downturn with confidence and in the long run, they outshine the market. But the fact is that with an established business model, they have less room for growth or expansion.
2. Mid-cap Companies
Mid-cap companies are ranked from 101 to 250 in terms of full market capitalization. Their market cap is less than ₹20,000 crores but more than ₹5,000 crores. Some of the top mid-cap companies in India are Cummins India, Polycab India, and CG Power and Industrial Solutions.
These types of companies hold a good track record but are more risky than large-cap stocks. At the same time, mid-cap ones work aggressively to become large-cap and there is a high space for growth and their returns can rise in the long term.
3. Small-cap Companies
As per the market capitalization definition of SEBI, small-cap companies are ranked 251 and below. Their market cap is less than ₹5,000 crores. Some of the top small-cap companies in India are K.P.R. Mill, Tata Chemicals, and J.B. Chemicals & Pharmaceuticals.
WHY SMC
- 20 Lac+ unique clients
- 33+ Years of Serving
- Advance Technical Analysis
- Free Demat Account
These companies are in the starting phase and with the probability of very high risk, they can grow exponentially. These stocks are highly volatile and suited only for high-risk investors.
Importance of Market Capitalization
After getting the nuances of what is market capitalization, it is important to know that it helps you analyze the current valuation of the company. With a change in market cap over the period, it signifies the company’s growth or fall.
Helps in Analyzing Liquidity
Companies are distinguished on the basis of market cap as large-cap, mid-cap, or small-cap. Large-cap stocks are more liquid (or easy to sell) than mid-cap or small-cap stocks because of their heavy trading. Similarly, mid-cap stocks are easier to sell than small-cap stocks. So, based on your liquidity needs you can directly invest in the stocks by checking the market capitalization. For example, forex market capitalization and its liquidity are very high in the world.
Helps in Matching the Risk Appetite
With the bracket of large-cap to small-cap stocks in terms of market cap, they can directly help you select a type of stock that matches your risk profile. With respect to risk level, large-cap are at the bottom and small-cap are at the highest level of risk.
Helps in Comparing Companies of the Same Industries
Market cap provides a direct way to compare companies that belong to the same industry or sector. For example, if a company has earned double the revenue from another company in the same industry. But its market cap is quite low, then this can be seen as an underperforming stock. And its stock price can rise further which eventually pushes its market cap.
Helps in Measuring Current Worth
Market capitalization meaning tells you that it measures the current worth of a company and how much it costs to buy the company based on its stock price. This does not include the company’s outstanding debt, liquid assets, or its long-term potential to grow. With the share price being the true or current belief of the public, the market cap is a sign of the company’s reputation or valuation.
Helps in Portfolio Creation
Creating a robust portfolio requires all sorts of stock holdings covering high risk-low return to low risk-high return stocks. Market cap broadly defines stocks on the basis of their risk-return earning profile covering large-cap, mid-cap, and small-cap stocks.
WHY SMC
- 20 Lac+ unique clients
- 33+ Years of Serving
- Advance Technical Analysis
- Free Demat Account
For example, if you want your portfolio to have 50% of stocks, then you can distribute 20% in large-cap, 20% in small-cap, and 10% in small-cap. This can vary according to your risk tolerance and investment objectives.
Helps in Analyzing the Impact of Corporate Actions
Corporate actions like buybacks or stock splits can also help you understand how it affects its current valuation. When the companies do the buyback exercise, it increases the price of remaining shares in the market, thereby leading to a rise in market cap.
When the companies issue new shares, the number of shares increases and hence the market cap rises. A stock split does not impact the market cap because the share price and the number of shares are both distributed in the same proportion.
What is Market Capitalization: Full and Free Float?
While searching for any stock information on BSE market capitalization, you may find two types of market cap, one is full market cap and the other is free float market cap. So, let’s understand what these two market caps signify.
Full market capitalization considers the outstanding number of shares that are publicly traded shares as well as the locked shares. You may find this NSE market capitalization as the total market cap.
On the other hand, free-float market capitalization considers only the shares that are publicly traded and does not consider the promoters or government shareholding (which are not publicly traded).
This means that the free float market cap of a company is less than its full market cap but it provides a more accurate picture of the company’s current valuation in the market.
Conclusion
After understanding what is market capitalization, it is clear that it is a key metric to review the company’s valuation. But the market cap is not a complete way to measure the stock’s performance and along with that, it requires some other key valuation ratios to reach a result of investing or letting go.
But whatever way you take to analyze the stock, it is better to start off early by opening the demat account with SMC Global Securities.
FAQs
1. Is market cap a good indicator?
WHY SMC
- 20 Lac+ unique clients
- 33+ Years of Serving
- Advance Technical Analysis
- Free Demat Account
Market cap is not a complete indicator to analyze any stock but it certainly helps you distinguish the size of the companies.
2. How is market capitalization calculated?
The market capitalization formula is equal to the number of shares of a company multiplied by its per-share price.
3. Why is market capitalization important?
Market cap is important as it helps in analyzing the risk level of a company, its financial position, and liquidity.
4. Which company is no 1 in market cap?
In India, Reliance Industries is the No.1 company in terms of market capitalization.
References:
https://www.investopedia.com/investing/market-capitalization-defined/
https://www.zeebiz.com/companies/news-what-is-difference-between-large-cap-mid-cap-small-cap-companies-stocks-market-capitalisation-formula-meaning-latest-news-update-218480
https://www.investopedia.com/terms/m/marketcapitalization.asp