Market capitalisation (commonly abbreviated to ‘market cap’) measures the absolute value that the share market is assigning to a listed company at any given time – nothing more, nothing less.
What do we mean by market capitalisation?
The whole purpose of a share market is to facilitate the buying and selling of ownership (shares) in publicly listed companies on a stock exchange, such as the ASX.
A company’s share price reflects this. The share price at any given moment is the middle ground between what potential buyers are willing to pay for the shares, and what potential sellers are willing to accept for their shares.
By determining this price, the market also assigns a value to the entire company. That’s because each company has a finite number of shares on issue. If Motley Fool Magic Beans (a hypothetical company, for the record) has 1 million shares outstanding and they are valued by the market at $1 a share, the market is effectively giving Motley Fool Magic Beans a market capitalisation of $1 million.
By the same logic, if the Motley Fool Magic Beans share price rises to $1.50 a share, then the market capitalisation also rises to $1.5 million.
So, the fluctuations in a company’s share price directly correlate with its market capitalisation at any given moment.
How can we calculate a company’s market capitalisation?
The formula for calculating a company’s market capitalisation is remarkably simple. You take the number of shares it has outstanding, and multiply by the company’s current share price. Here’s a formula to demonstrate:
Market Cap = No. of Shares Outstanding x Current Share Price
That will give you an accurate market capitalisation for the company as a whole.
Large cap, small cap, micro cap – what do these terms mean?
You might have come across some ‘sizes’ when investors talk of market caps. Large cap, mega cap, mid cap and small cap are common terms, and you may have also heard of micro cap or even nano cap shares.
Company size is a useful way to group investments. For example, if you’re a large-cap investor, then you only buy the big listed companies with the largest market capitalisations.
Company size also helps define what kind of businesses an index, analyst or fund manager might cover. For example, a micro-cap analyst is only interested in very young companies with small market capitalisations.
It’s very common for investors to pigeonhole a company based on its size, or market cap.
There are no universal rules dictating what a large cap or small cap share is, but here is a common framework:
A mega cap share typically has a market capitalisation of $200 billion or higher. These don’t yet exist on the ASX, so this is a term you might find more commonly used over in the United States.
Large cap shares have a market capitalisation of $10 billion or higher. All of the ASX 50 blue chip companies come under this label.
A mid cap share usually has a market capitalisation of between $2 billion and $10 billion. These shares aren’t usually labelled blue chips, but can still be found in the ASX 100.
Small caps are companies with a market cap that can range from a few hundred million up to $2 billion. These companies won’t normally be found in the ASX 100, but might still show up in the S&P/ASX 200 Index (ASX: XJO). The Small Ordinaries Index (ASX: XSO) aims to cover small cap shares by excluding the ASX 100 from its listings.
Micro cap companies are often called ‘penny stocks’ and have market capitalisations typically ranging from $50 million to $300 million. Most ASX investors shy away from investing in this space as it is regarded as a ‘high-risk, high reward’ arena.
Any listed share with a market capitalisation of $50 million or less can be labelled nano cap. These are extremely speculative investments as there is usually very little research or data available to retail investors.
Does market capitalisation matter?
When an investor attempts to value a company using a price-to-earnings (P/E) ratio or similar metric, what they are really doing is measuring the company’s market capitalisation against its profitability or cash generation.
In this way, market capitalisation is a useful tool in investing, and can greatly assist you in determining the right share price to buy a company at.