Market capitalisation (commonly abbreviated to market cap) is a term you will probably have come across if you have spent any time around the share market. It is one of the most common statistics that an investor will seek on a company – and for good reason too. Market capitalisation measures the absolute value that a market is assigning to a company, nothing more or less.
What do we mean by market capitalisation?
The whole purpose of a share market is to facilitate the buying and selling of ownership in any company that’s publicly listed on a stock exchange (such as the ASX). A company’s share price reflects this. The share price of a company 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 sell the shares at.
By determining this price, the market is also assigning 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 of 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 simply take the number of shares a company has outstanding, and multiply it 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 some across some ‘sizes’ when investors talk of market caps. Large cap, mega cap, mid cap and small cap are common terms, but you may have also heard of ‘micro cap’ or even ‘nano cap’ shares.
As a company’s size is a useful way to group certain investments, or else ‘define’ what kind of company an investor, index or fund manager might cover, it’s very common for investors to pigeonhole a company depending 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, and 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 kinds of 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 are those with 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 under can be put in the nano cap pigeonhole. These are extremely speculative investments as there is usually very little research or data available for 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 how profitable a company is or how much cash it generates. In this way, market capitalisation is a useful tool in investing, and can greatly assist you in finding the ‘right’ share price to buy a company at.