by Amanda Harvey
Stock market capitalization, often referred to as ‘market cap,’ is the term for the figure used to depict the market value of a company. This figure is determined by the total number of outstanding shares multiplied by the current price at which these shares are trading. The outstanding shares of a company are otherwise referred to as issued shares, and this number includes publicly owned shares held by investors, as well as restricted shares which are held by the company’s officials or employees.
It is important to realize that while the market cap gives a simple and easily calculated way of understanding a company’s market value as well as its size, it does not give a clear indication of the intrinsic value or equity value of the company. Stock market capitalization may give an inaccurate picture of a company’s real value due to the overvaluing or undervaluing of shares that often occurs as a result of hype or other factors.
Factors Affecting Stock Market Capitalization
There are two major factors which influence a company’s market cap, and these are directly correlated to the two areas used in calculating market cap. The first is the number of outstanding shares issued by the company. The number of outstanding shares will increase in the event of the company issuing additional shares, and will decrease if the company buys back shares from investors in a transaction known as share repurchase. An increase in the number of outstanding shares will obviously be reflected in the rising of the company’s market cap, while a reduction in the quantity of shares will cause a lowering of the market cap.
The other reason for the raising or lowering of a company’s market cap is the increase or decrease of stock prices. Due to the fact that the price of stocks is always changing, a company’s market capitalization also reflects this fluctuating value.
The Relevance of Stock Market Capitalization to Traders
The size and market value of a company can provide valuable insights into the investment potential and risk profile of buying shares or trading options for that company. Companies are grouped into broad classifications based on their market cap. In the simplest terms, companies fall into large-cap, mid-cap, or small-cap.
A large-cap company is one that has a market value of 10 billion US$ or higher. If this figure is as high as $300 billion or above, they are termed as mega-cap companies. The size of these companies generally indicates a long-standing and well established position as market leaders in their sectors. They are considered to be stable, and to present investment opportunities with a relatively low risk factor, but also with limited likelihood of large amounts of rapid growth.
A company with a market value of between $2 billion and $10 billion is classed as a mid-cap company. These companies are considered to contain a higher level of risk than large-cap companies as they are less established, but also offer greater growth potential.
Companies with stock market capitalization of over 300 million US dollars and under $2 billion are referred to as small-cap companies, while a company with a market value of less that $300 million is termed as a micro-cap company. These companies generally have an even higher risk factor than mid-cap companies, but are attractive to some investors for their possibility of exponential growth.
Understanding what stock market capitalization is and how it helps to choose stocks or options with a risk and profit potential suited to your trading style can be a simple and effective component of building your trading strategy.