Market Capitalization: Not the Only Important Investment Metric
Market capitalization (market cap) is one of several methods used to rank companies based on their size. Although there are many potential ways to measure a company’s size, the market cap provides an easy way for investors to compare different companies’ values.
A company’s market capitalization refers to the total value (in dollars) of all of its traded shares. This number can be calculated by multiplying the price per share by the total number of outstanding shares of the company.
Knowing a company’s market capitalization is especially useful when comparing different companies or tracking a company over time because it does not fluctuate as much as other forms of value, such as net income or revenues.
How to Calculate the Market Cap
To calculate the market cap of a company, use the following equation:
Market Capitalization = Current Market Price per Share x Shares Outstanding
For example, if Company A has 100 million shares outstanding and each share is valued at $10, then its market capitalization would be $1 billion. If Company B also has 100 million shares outstanding but each share is valued at $5, then its market capitalization would be half of Company A’s, or $500 million.
Why Investors Care about the Market Cap
The market cap allows investors to compare the value of different companies and make decisions about where to invest their money. Some investors look for high growth potential and attempt to invest in small-capitalization companies, while others seek out lower-risk or slower-growth companies and focus on large-cap stocks.
For example, a technology investor would likely want to invest in a high-growth, small-cap company that specializes in computer chips, while a retiree may want to invest in a lower-risk large-cap company such as an insurance firm. Generally speaking, companies with a higher market capitalization are considered safer investments because they have more money to cushion against potential losses.
Percentage of the Market Cap
The percentage of a company’s market capitalization can also be useful for investors. For example, if one stock has only a 1 percent share in the total market cap and another stock has 10 percent, then it means that the first stock is relatively small and therefore risky, while the second stock is pretty significant and likely to be considered a safer investment. The percentage of the market cap is just the company’s market capitalization divided by the total market cap.
Using the previous example, if Company A has $1 billion in market capitalization and the total market cap for all companies is $100 billion, it means that Company A has 1 percent of the total market share. Company B has $500 million in market capitalization and the total market cap is still $100 billion, so this means that it has half of a percent of the total market share.
Advantages of Investing in Companies with a High Market Capitalization
Investors often want to invest in companies with high market capitalizations for several reasons, such as:
- The company is big and well-known in its industry, which means the stock price could be less volatile.
- The company has a larger number of shares outstanding, which leads to lower share prices and higher dividend payouts.
- The company is more likely to get the attention of money managers, who often buy large-cap stocks for their clients.
Disadvantages of Investing in Companies with a Low Market Capitalization
Small-capitalization companies typically grow faster than large-cap companies, which can result in greater returns for investors. However, there are several disadvantages to investing in small-cap companies:
- The share prices can be more volatile than large-cap company shares.
- Small-capitalization companies could have fewer resources at their disposal and therefore may not be able to withstand negative press or unexpected events as well as larger companies.
- Small-capitalization stocks may not be as attractive to money managers because their share prices are usually higher, which means they would have a low “buying power.”
Although market capitalization is one of the most important factors when considering an investment, it should only be used to compare certain companies. Some investors also consider other company data, such as cash flow per share, earnings per share, and sales growth.
Other Factors that Influence an Investor’s Decision to Buy Shares from a Company
In addition to market capitalization, investors also consider different factors when they decide whether or not to invest money into a company. For example, some investors may avoid investing in an oil and gas company because of concerns about global warming and pollution, while other investors might be willing to look past those issues and invest in the company if it is producing high returns. Other factors that may influence an investor’s decision include the company’s management, how long it has been in business, and whether or not its leaders are visible in their community or industry.
When Is Market Cap Useful, and When May It Not Be the Best Metric to Understand Elements of A Company?
Although the market cap is useful in comparing companies against each other, it does not always accurately reflect a company’s health or stability. For example, just because Company A has twice as many shares outstanding compared to Company B does not necessarily mean that it is worth more money overall. Other factors, such as what industry the company operates within, are also important when determining if the market cap is a good indicator of company value.
Market capitalization can be useful for investors who are looking to invest in large-cap, mid-cap, or small-cap companies. Investors should remember that this metric does not take any other factors into consideration – such as dividend payouts, earnings per share, or a company’s financial strength – and should be used in conjunction with other metrics when making any investment decisions.
The market cap is an important investment metric that can help investors get a general idea about how much money is circulating in the total value of shares sold by a company. When used together with other factors, such as growth potential and company size, the market cap can help investors make more informed decisions about where to invest their funds if they want to have a positive impact on their overall financial success.