What is market cap?
Editorial staff, J.P. Morgan Wealth Management
- Market capitalization, or market cap, is calculated by multiplying the total number of shares of a company’s stock by its current market price.
- Market cap includes all of a company’s shares, whereas free-float market cap refers only to the number of outstanding shares that can be traded by the investing public.
- Market cap is broken down into five segments: mega, large, mid, small and micro.
- Aside from differentiating companies based on their size, market cap provides a real-time snapshot of what investors are willing to pay for a company’s stock.
- Market cap can be used as an indicator of the riskiness of a stock.
What does market cap mean?
Market cap, short for market capitalization, measures a company’s value in dollar terms. This is calculated by multiplying the total number of shares of a company’s stock by the current market price of that stock.
For example, a company with 100 million shares of stock with the market price of $20 per share would have a market cap of $2 billion.
There is a distinction between market cap and free-float market cap. The latter refers to the number of outstanding shares that can be traded by the investing public, while the former includes shares that are not available to the public. Generally, when the term market cap is brought up, it refers to the free-float figure.
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Ranges of market capitalizaiton
Traditionally, market capitalization has been broken down across three segments: large, mid and small. However, with the values of publicly traded companies ranging from the low millions to trillions, it has become necessary to widen the classification spectrum.
Currently, the widely used ranges to segment market cap are:
- Mega: $200 billion-plus
- Large: $10 billion to $200 billion
- Mid: $2 billion to $10 billion
- Small: $250 million to $2 billion
- Micro: Less than $250 million
Why is market cap important?
The importance of market cap lies in its simplicity in that it is easily understood by investors. Aside from differentiating companies based on their size, it provides a real-time snapshot of a company’s worth on the open market. This is crucial as it gives an indication of what the investing public is currently willing to pay for that company’s stock. This, along with other company-specific metrics, can provide a valuable guide to the market’s perception of a stock’s future value.
Also, investors can use the different ranges of market cap as an approximation for varying levels of risk. For example, mega-cap stocks will likely be less risky than micro-cap stocks as they are larger, have greater liquidity and are less susceptible to market manipulation.
Enterprise value vs. market cap
Enterprise value (EV) is the total value of a company, while market capitalization refers solely to the value of its equity. Basically, market cap is a part of a company’s enterprise value. Here’s a look at how market cap and EV are calculated:
- Market cap = Current share price × number of shares
- EV = market cap + total debt − cash
How to use market cap
Market cap is integral in the calculation of several financial ratios that are popular in the investment community. Simply put, any ratio that begins with “price to” will likely be utilizing market cap. For example, price to earnings (P/E) ratio is calculated by dividing market cap by net income generated (earnings), usually for either the trailing or the projected future 12-month period.
Most investors, especially ones with longer-term time frames, tend to be mindful of the risk-reward relationship. They opt for diversification in their portfolios. This, invariably, means that the composition of their portfolios will have stocks with different market caps. Financial professionals take into account a stock’s market cap to guide them in tailoring their clients’ portfolios according to their desired goals.
A conservative investor looking for stability might allocate a greater portion of the funds to large- and mega-cap stocks. This may mitigate the riskiness of the portfolio but dampen its growth prospects as well.
Conversely, an investor who wants to focus on growing the size of their portfolio might choose to allocate more to small- and micro-cap stocks. While the potential for reward is higher, so too is the risk level of this portfolio.
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Editorial staff, J.P. Morgan Wealth Management
