Market capitalization, commonly called market cap, is the total market value of a listed company, calculated as its current share price multiplied by its outstanding shares. It is one of the simplest ways to gauge a company's size in the stock market.
In this blog, we will learn more about what market cap is, how market capitalization is calculated, and why it matters when selecting stocks. Let’s understand.
What is Market Capitalization?
Simply put, market capitalization is the total market value of a company's outstanding equity shares.
The market cap meaning becomes easier to understand through its two components. The current market price represents the market's valuation of each share, while the number of outstanding shares represents the total equity shares held by shareholders.
In simple terms:
Market Capitalization = Current Market Price per Share × Total Outstanding Shares
For example, suppose Company Z has a share price of ₹500 per share and 10 lakh outstanding shares.
Its market capitalization would be:
₹500 × 10 lakh = ₹50 crore
Therefore, the company's market cap would be ₹50 crore.
Market capitalization changes with the company's share price. If the share price rises while the number of outstanding shares remains unchanged, the company's market cap also rises. Similarly, a fall in the share price generally reduces market capitalization.
However, market cap should not be treated as the same thing as the company's book value, enterprise value or the amount required to acquire the entire company.
Market Capitalization Formula
The market capitalization formula is:
Market Capitalization = Current Market Price of a Stock × Total Number of Outstanding Shares
How to Calculate Market Capitalization?
To understand how to calculate market capitalization, you only need two figures:
- Current market price of the company's share
- Total number of outstanding shares
Example
Suppose a company has:
- Current share price: ₹500
- Outstanding shares: 10 lakh
Then:
Market Capitalization = ₹500 × 10,00,000
= ₹50,00,00,000 or ₹50 crore
This gives you the company's market capitalization at that particular share price.
Since share prices fluctuate during market hours, a listed company's market cap can also change throughout the trading session.
Types of Market Capitalization
Market capitalization helps classify companies according to their size. In India, SEBI's classification of large-cap, mid-cap and small-cap companies is based on their ranking by full market capitalization.
The classification is:
AMFI prepares the list of stocks in consultation with SEBI and recognised stock exchanges, using market capitalization data from the exchanges. The list is updated every six months based on market data as of the end of June and December.
1. Large-Cap Companies
Large-cap companies are those ranked from 1st to 100th in terms of full market capitalization.
These are generally well-established businesses with relatively mature operations and significant market presence. Examples include Reliance Industries, Tata Consultancy Services, and HDFC Bank.
Large-cap stocks are generally considered less volatile than mid-cap and small-cap stocks, although they are not risk-free. Their established businesses may provide greater stability, but their size can also mean their growth rate is slower than that of smaller companies.
2. Mid-Cap Companies
Mid-cap companies are ranked from 101st to 250th based on full market capitalization.
These companies generally fall between large-cap and small-cap stocks in terms of size and risk. Some may be established businesses with significant growth opportunities, while others may be expanding rapidly.
Mid-cap stocks can offer a balance between growth potential and stability, but they can also experience larger price movements than large-cap stocks.
3. Small-Cap Companies
Companies ranked 251st onwards in terms of full market capitalization are classified as small-cap companies.
These businesses may have greater room for expansion, but they can also carry higher business and market risks. Their share prices can be more volatile, particularly during periods of market stress.
Small-cap stocks may suit investors who understand the associated risks and have a longer investment horizon. However, suitability also depends on an investor's risk tolerance and financial goals.
Importance of Market Capitalization
After understanding what market capitalization means, it is important to know how this metric can help investors.
Market cap does not tell you whether a stock is cheap or expensive. Instead, it gives you an idea about the size of a company and can be used alongside other financial and valuation metrics.
Helps in Understanding Company Size
Market capitalization provides a quick way to compare the relative size of listed companies.
For example, a company with a ₹2 lakh crore market cap is considerably larger in market-value terms than a company with a ₹2,000 crore market cap.
However, size alone does not indicate that one company is a better investment than another.
Helps in Assessing Risk
Market-cap categories can provide a broad indication of the risk characteristics of different companies.
Large-cap stocks are generally considered relatively more stable, while mid-cap and small-cap stocks can have greater growth potential as well as higher volatility.
Investors can use this classification when building a portfolio according to their risk tolerance and investment horizon.
Helps in Comparing Companies in the Same Industry
Market cap can also be useful when comparing companies operating in the same sector.
For example, if two companies operate in the same industry, comparing their market capitalizations alongside revenue, earnings, margins and valuation ratios can provide a better understanding of their relative position.
Market cap alone, however, should not be used to decide whether a stock is undervalued or overvalued.
Helps in Portfolio Creation
Market capitalization can be useful when constructing a diversified equity portfolio.
An investor may choose to hold a combination of large-cap, mid-cap and small-cap stocks depending on their investment objectives, risk appetite and time horizon.
For example, an investor with a higher risk tolerance and longer investment horizon may allocate a portion of their portfolio to mid-cap and small-cap stocks. In contrast, another investor may prefer greater exposure to large-cap companies.
The appropriate allocation depends on individual circumstances.
Helps in Understanding Corporate Actions
Corporate actions can affect the number of outstanding shares and, consequently, a company's market capitalization.
For example, in a stock split, the number of shares increases while the share price adjusts proportionately. Therefore, a stock split by itself does not change the company's market capitalization.
Similarly, a buyback can reduce the number of outstanding shares. The impact on market capitalization will depend on the buyback price and the resulting share price.
If a company issues new shares, the number of outstanding shares increases, which can affect its market capitalization.
What is Full Market Capitalization and Free-Float Market Capitalization?
When looking at stock market data, you may come across full market capitalization and free-float market capitalization.
Full Market Capitalization
Full market capitalization reflects the total number of a company's outstanding shares.
The calculation is:
Full Market Capitalization = Current Share Price × Total Outstanding Shares
Free-Float Market Capitalization
Free-float market capitalization considers only those shares that are readily available for trading in the market.
Certain shareholdings that are not normally available for public trading, such as promoter holdings and certain strategic holdings, are excluded when calculating free-float market capitalization.
As a result, a company's free-float market capitalization is generally lower than its full market capitalization.
Free-float market capitalization is particularly important when constructing market-cap-weighted indices because it reflects the portion of a company's equity that is actually available for public trading.
Market Cap vs Company Value
One common misconception is that market capitalization represents the complete value of a company.
It does not.
Market cap represents the market value of the company's outstanding equity shares. It does not directly account for the company's debt, cash or other factors that are considered when calculating measures such as enterprise value.
Similarly, a high market cap does not automatically mean that a stock is overvalued, and a low market cap does not necessarily mean that a stock is undervalued.
Investors should consider market capitalization along with earnings, cash flows, debt, valuation ratios, business prospects and other fundamental factors.
Top Companies by Market Cap
The list of top companies by market cap can change over time because share prices and the number of outstanding shares can change.
Therefore, investors should refer to current exchange or market data rather than relying on a static list.
A company's position among the largest companies can change when its share price rises or falls relative to other listed companies.
Conclusion
After understanding what market cap is, it is clear that market capitalization is an important metric for understanding the size and relative market value of a listed company.
The market capitalization formula is simple: multiply the current share price by the number of outstanding shares. Investors can then use market cap to broadly classify companies as large-cap, mid-cap or small-cap and understand the different characteristics associated with each category.
However, market capitalization is only one part of stock analysis. Before investing, it is important to consider factors such as revenue growth, profitability, debt, valuation ratios, cash flows and the company's future growth prospects.
If you plan to invest in stocks, you can open a Demat account with SMC Global Securities to explore a range of investment opportunities.
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