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A Look at Market Capitalization

17 June 2008 - Features - Editor

A public company’s market capitalization (also referred to as market cap) is the total market value of its outstanding shares i.e. all issued shares in the hands of investors. This measurement of corporate or economic size of a company is calculated by multiplying the number of outstanding shares by the price of one share, thereby providing a total value for the company’s shares, and therefore for the company as a whole. Instead of using sales or total asset figures to determine the size of a company, investors make use of market capitalization figures.

For example: Joe Soap Inc. has 20 million shares outstanding and each of these shares has a market value of $50. The company’s market capitalization would be 20,000,000 x $50 = $1,000,000,000 or $1 billion. Based on this figure, investors determine whether the company is large, medium or small, generally referred to as large-cap, mid-cap and small-cap respectively. There is no clear-cut definition as to what constitutes a large-cap, mid-cap or small-cap company. Although some investment professionals may disagree, the most widely accepted categories are that the market capitalization of a large-cap company is $10 billion or more, mid-cap is from $2 billion up to $10 billion and small-cap is less than $2 billion. The term mega-cap has been coined for companies with a market capitalization of more than $1 trillion.

Large-cap companies are also often referred to as “blue chip” companies, with their stock being referred to as “blue-chip stock”. A blue-chip company is well established with stable earnings. Blue-chip stocks pay dividends on a regular basis, even when business is slower than usual. The term “blue-chip” is taken from gambling, where the blue chips represent the highest value.

Bearing in mind that owning stock means owning a part of the company, market capitalization is seen as an indication of public view of a company’s net worth. This in turn is a determining factor in stock valuation. Many public companies have a dominant shareholder, such as a government entity, family members, or another corporation. Should this be the case, a number of stock market indices make adjustments for this by removing the dominant shareholder’s stocks from the equation and calculating the market capitalization based on the value of the publicly tradable number of the company’s shares. Stock market indices that make this adjustment include Sensex, FTSE, Nikkei, DAX, MSCI and S&P 500.

 


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