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What is market capitalization?
Market capitalization is one way of measuring a company’s value, but it has limitations.
Market capitalization — also known as market cap — is the measure of a company’s market value as determined by participants on the stock market. In other words, the market cap doesn’t show the company’s underlying value; it shows the company’s value as determined by investors at the moment.
Understanding market capitalization
To understand market capitalization, you need to know how it’s calculated. First, find the number of shares a company has and multiply it by the stock price.
Let’s say Company X has 1 million shares, and the current market price is $10 per share.
1 million shares x $10 per share = $10 million
Company X has a market cap of $10 million.
Because market cap is directly related to the stock price, it can be very volatile — especially with smaller companies. Sometimes a company’s market cap can change from $50 million to $10 billion in a matter of weeks or months.
How to use market cap
Use market cap to get a quick look at any company. For example, if the company has a huge market cap of hundreds of billions of dollars, it usually means the company has been doing the right thing for years, and it’s a low-risk investment. Companies with a market cap of $50 million or less often show high risk –– but this risk brings the potential for high rewards.
There are five types of companies based on market cap.
|Type of company||Market cap range|
|Large-cap||$10 billion to $200 billion|
|Mid-cap||$2 billion to $10 billion|
|Small-cap||$300 million to $2 billion|
|Mega-cap||Over $200 billion|
|Micro-cap||Less than $300 million|
Large-cap companies, also known as “big cap,” are companies worth more than $10 billion on the stock market. These companies are fewer in number than all other companies with lower market cap as measured by the Wilshire 5000 Total Market Index. But the market value of all the large-cap stocks makes up more than 90% of the index.
These are often large, established companies that have been around for many years. Typically, they may not bring huge rewards in the short term, but they are known to be profitable in the long run. Some of these companies may even distribute dividends, which is another incentive to keep them on your radar.
Some large-cap companies include:
- Chevron Corp
- Abbott Laboratories
- Merck & Co
- Wells Fargo
- United Parcel Service
- Morgan Stanley
- The Boeing Co
Mid-cap companies have a market capitalization of between $2 billion and $10 billion. These companies are well-established and are expected to grow in the future. Because of their growth potential, these are typically considered to be higher risk than large-cap companies but have a higher reward potential as well.
Some mid-cap companies include:
- Beyond Meat
- Opendoor Technologies
- Under Armour
- Wyndham Hotels & Resorts
- Texas Pacific Land
- Skechers USA
- Brooks Automation Inc
- Floor & Decor Holdings
- Mirati Therapeutics
Small-cap companies have a market cap of between $300 million and $2 billion. These are often either new companies or serve niche markets, such as technology or pharmaceuticals. They are considered higher risk than mid- and large-cap companies but also have a much higher growth potential.
Some small-cap companies include:
- Bed Bath & Beyond
- FuelCell Energy
- Golden Nugget Online Gaming
- Meridian Bioscience
- Ocular Therapeutix
- Riot Blockchain
- Workhorse Group
- Vanda Pharmaceuticals
Mega- and micro-cap companies
Aside from the three major distinctions used to compare the market capitalization of companies, there are two more: mega-cap and micro-cap.
- Mega-cap refers to companies with a market cap of $200 billion or more. These are well-established companies and typically come with the lowest investment risk and decent long-term rewards. These include Apple, Amazon, Facebook and Microsoft.
- Micro-cap refers to companies with a market cap of less than $300 million. Micro-caps are often niche companies with low share prices –– defined as less than $5 per share. Choosing the right one can be profitable, but it comes with a massive risk of failure. These include Koss Corp, Zedge, First Bank and Evofem Biosciences.
3 limitations of market cap
Market cap is a useful measure for companies you want to invest in, but the measure is limited in these three ways.
- Market cap only shows the company’s value as perceived by market participants. A company can have a much-higher or much-lower market cap than it’s really worth.
- Market cap can rapidly change. Market cap is directly connected to the share price. If there are sharp moves in the stock price, the market cap could change dramatically.
- Example: GameStop (NYSE:GME), which took off in January 2021 after a short squeeze initiated on Reddit board wallstreetbets, had a market cap of almost $15 billion in June 2021, making it a large-cap stock. Eight months ago, the company was a micro-cap with a market cap of about $260 million.
- Doesn’t determine acquisition cost. Even though the market cap shows the company’s market value, it doesn’t show the company’s acquisition price.
- Calculation: (Company’s total debt + market cap) – company’s cash = acquisition price.
4 other ways to analyze stocks
Market cap is not the only factor you could use when researching companies to invest in. Here are four other ways you could analyze stocks.
- Technical analysis. Technical analysis uses price charts to determine patterns in market behavior, mainly supply and demand but also fear and greed. Technical analysis provides an indicator of where the price could move next.
- Earnings per share (EPS). This metric is calculated when the company’s profit is divided by the outstanding shares of its common stock.
- Book value. This number shows the amount of money required to pay the shareholders if the company is liquidated. To calculate this number, use total assets minus liabilities.
- Analyst recommendations. You can save time by following analysts’ recommendations. Some brokerage firms like IBKR provide access to such services.
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Market capitalization shows the company value as determined by the stock market, which can help you determine which stocks to invest in. Companies with large market cap are often low-risk investments but with a lower growth potential than smaller companies.
To learn more about stock trading, check out our guide to investing.
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