The term 'Market Capitalization' is included in the Corporate Finance edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Market capitalization refers to a company’s total value. Analysts determine it by multiplying the number of shares in existence times the price of the stock. This concept can also be utilized to measure the full value of a stock exchange. The New York Stock Exchange market capitalization would equal the value of all publicly traded companies on the exchange added together.
Market cap is another name for market capitalization. Examples of how this is figured make it easier to understand. Companies that have 2 million shares which have been issued that sell for $20 apiece have a market cap of $40 million. If an investor had enough money and could get the stockholders to agree to sell their shares, he or she could purchase the company for $40 million total. In practice many shareholders would want more than the current share price to sell their stock.
There are three different main sizes of market capitalization among traded companies. These are large cap, mid cap, and small cap corporations. Large cap companies are generally considered the least risky ones in which to invest. They typically possess substantial financial resources to survive economic downturns. They are also generally leaders in their industries. This gives them a smaller amount of growth opportunity.
Because of this the returns for these large cap companies are often not as spectacular as with successful companies in the other two categories. They also have a significantly greater chance of paying dividends out to their share holders. Large cap corporations have $5 billion and higher capitalization.
Mid cap companies are generally less risky than the smaller companies. They still do not have the same possibilities for aggressive growth. Mid cap companies commonly possess market capitalization of from $1 billion to $5 billion. Studies have shown that mid caps have outperformed large cap and small cap corporation stocks in the past 20 years.
Small cap corporations are those which possess under $1 billion in market capitalization. These tinier companies have often completed an Initial Public Offering in the recent past. Such companies are considered the riskiest of the three types. This is because in economic downturns, they have the greatest chance of failing or defaulting. They also enjoy plenty of opportunity and space to expand. This means that they potentially could be extremely profitable if they succeed.
Proponents of using market cap as the primary means of valuing companies have a well thought out argument. Stock prices tend to reflect the beliefs of investors and analysts in the anticipated earnings of a company. Higher earnings should cause traders and investors to bid up the price of the stock. Multiplying this price by the number of shares gives a comparable means of valuing one company against another.
A downside to valuing businesses this way is that it can give companies without profits high valuations. In the dot com bust at the turn of the century, technology companies that had never turned a profit were valued in the tens of billions of dollars. This in theory made them more valuable than reliable companies that had actual assets and earnings. Companies in slower growing industries are also typically valued less than they should be since their stock prices are often undervalued. Critics of this way of valuing companies suggest that more accurate measures would include the value of a company’s assets, its annual revenues, or its earnings per share.
Companies whose market capitalization falls substantially below their asset value become takeover targets. This is because corporate raiders are able to buy a company for less money than they will realize by selling off its various parts, businesses, and assets separately.