Market Capitalization: What is it and How to calculate it

What is market capitalization? And how is it calculated?
Also known as the stock capitalization, market capitalization or market cap, this value helps investors understand the size of a company listed on the financial markets.

Here is a comprehensive guide on the parameter that profoundly alters the perception of global financial markets.

What is market capitalization

The market capitalization of a listed company measures, simply put, its size. The total value of a company is a parameter that is highly regarded by stock market operators, as it offers various ideas for effectively calibrating investments.

In fact, investors tend to consider high-cap stocks more solid than those with a low value. In fact, the shares of the latter may be more vulnerable to periods of adverse economic times, such as recessions or periodic market fibrillations.

However, there is no inverse relationship between the size of the market capitalization and the investment risk. This is, in part, due to the fact that the Market Cap does not include all the information necessary to assess the health of a company, such as – for example – details of the company’s balance sheet or capital structure.

Additionally, a stock’s share capitalization is often inflated by the expectations that investors place on the company. A clear case in this context has long been that of Tesla, which despite low profitability has long enjoyed the trust placed by the markets in the future development of the electric car sector.

How to calculate the market value of a company

The stock market value of a company can be calculated by carrying out a basic operation. In fact, it is sufficient to multiply the number of shares of a given company listed on the market by the current price.

In other words, share capitalization measures the aggregate value of a company’s shares outstanding, i.e. the free float. Clearly, this parameter is not fixed but subject to continuous movements – upwards or downwards – on the financial markets.

In fact, investors are often influenced by news relating to specific companies or sectors: an information flow which can induce the markets to unload the shares or even to double the bets. Consequently, the market capitalization of a company is exposed to the moods of the Stock Exchange which, as evidenced by numerous studies in the field of behavioral finance, are often fueled by human irrationality.

The formula for market capitalization is then:

Market capitalization = share price * number of shares outstanding

Attention! The size of a company is NOT directly proportional to its share price: a company whose share price value is twice as high as another will not necessarily be twice as large. Always remember to consider the number of shares outstanding (and therefore the company’s total market capitalization) when analyzing stocks.

The utility of market capitalization

Determining the value of a company is an important and often complex task. This concept is extremely important to investors, as it is an indicator of public opinion regarding the value of a company. This value is also taken into account in acquisitions, in order to determine whether or not the candidate company is of good value to the buyer.
Market capitalization is a quick and easy way to estimate the value of a company, as it allows you to define the value of publicly traded companies according to the market. Defining the size of a company is in fact important for investors, as this factor determines various characteristics in which these stakeholders are interested, including risk.

Investment strategy and portfolio diversification

Given its simplicity and effectiveness for assessing risk, market capitalization can be a useful measure for investors to determine which stocks they find attractive and how to diversify their portfolio with companies of different sizes.

Indeed, it is possible to classify companies into categories, based on their capitalization size in USD:

• Large-cap companies: Have a market capitalization of more than $10 billion. These companies have usually been around for a long time and are major players in established industries. Investing in large-cap companies doesn’t necessarily bring huge returns in a short period of time, but over the long term, these companies generally reward investors with steady growth in stock value and dividend payments.
• Mid-cap companies: They generally have a market capitalization of between $2 billion and $10 billion. They are usually established companies that belong to a rapidly growing sector. Mid-cap companies are on the rise. They are inherently riskier than large-cap companies because they are not as established, but they are attractive for their growth potential.
• Small-cap companies: have a market capitalization ranging from $300 million to $2 billion. These are often young companies that can serve niche markets and new industries. These companies are considered higher risk investments due to their age, the markets they serve, and their size. Smaller companies with fewer resources are more sensitive to economic slowdowns. As a result, the prices of smaller-cap stocks tend to be more volatile and less liquid than larger, more mature companies. At the same time, small companies often offer more growth opportunities than large caps.
• Micro-cap: Companies with valuations ranging from approximately $50 million to $300 million.

Market capitalization can be an invaluable tool for an investor interested in the stock market, as it is a quick and easy way to estimate the value of a company. Choosing the financial intermediary to rely on, both for your training and investments, is extremely important: choose a regulated and globally recognized broker such as XTB, allows you to access complete and free training, as well as benefit from greater security than other institutions, as your funds are segregated by those of the company, which is regulated by the most important financial regulatory institutions.

Original article published on Money.it Italy 2022-12-27 10:46:00. Original title: Capitalizzazione di mercato: cos’è e come si calcola