How to Calculate Stock Market Capitalization and Why It Is Important explained by professional Forex trading experts the “ForexSQ” FX trading team.
How to Calculate Stock Market Capitalization and Why It Is Important
A company’s stock market capitalization is an important concept that every investor should understand. Although market capitalization is often discussed on the nightly news, used in financial textbooks, employed as an approximation of the relative influence and importance of a business, and even determines the component list and weightings of various stock market index funds or individual portfolios following mainstream asset allocation modes, you may not know how stock market capitalization is calculated or how it differs from the closely-related enterprise value figure that arises in discussions of mergers and acquisitions.
In the next few moments, I’m going to help change that, empowering you to
The Definition of Stock Market Capitalization
Put simply, stock market capitalization is the amount of money it would cost if you were to buy every single share of stock a company had issued at the then-current market price.
How to Calculate Stock Market Capitalization
The formula for calculating stock market capitalization is as simple as it sounds. There are no tricks or weird quirks to consider. It’s this straightforward:
Stock Market Capitalization = Current Shares Outstanding x Current Stock Market Price.
Real-World Examples of How to Calculate Stock Market Capitalization
For example, when I first wrote this article many years ago, The Coca-Cola Company has 2,317,441,658 shares of stock outstanding and the stock closed at $49.60 per share. If you wanted to buy every single share of Coca-Cola stock in the world, it would cost you 2,317,441,658 shares x $49.60 = $114,945,106,236.80.
That was just shy of $115 billion. On Wall Street, people would have referred to Coca-Cola’s market capitalization as $115 billion. Contrast that the present. Coca-Cola has 4,316,029,450 shares outstanding and the stock closed at $43.32 as of Friday, August 26, 2016. That means Coke’s stock market capitalization is $186,970,395,774, or $187 billion.
The Strengths and Weaknesses of Stock Market Capitalization
Stock market capitalization can allow investors to understand the relative size of one company versus another, ignoring specifics about capital structure that cause the share price of one firm to be higher than another firm. For example, compare Coca-Cola at $43.32 per share with retailer AutoZone at $753.47 per share. Despite having an exponentially larger share price, the latter has a stock market capitalization of $22 billion; a mere fraction of Coke’s. The share price as presented is an accounting quirk resulting from the total outstanding shares a company’s board of directors has permitted to exist through its use of things such as stock splits. To learn more about this topic, check out my article How to Think About Share Price, which walks you through the math, explaining how a $300 stock might be cheaper than a $10 stock.
On the flip side, stock market capitalization is limited in what it can tell you. The biggest downfall of this particular metric is that it does not factor into consideration a company’s debt. Consider Coca-Cola once more. The company has around $67 billion in debt and other liabilities that, were you to buy the entire business, you would be responsible for servicing and repaying.
That means, while Coke’s stock market capitalization is $187 billion, it’s enterprise value is $254 billion because, simplified and all else equal, the latter figure is what you would need to not only buy all of the common stock but pay off all the debt, too. To learn more about this topic, read my article Enterprise Value – Determining the Takeover Value of a Company.
Another major weakness of using stock market capitalization as a proxy for a company’s performance is that it does not factor in changes in per share value or distributions such as spin-offs, split-offs, or dividends, which are extremely important in calculating a concept known as total return. It seems strange to many new investors but total return can result in an investor making money even if the company itself goes bankrupt.
For one historical example, look at the long-term performance of the collapse of Eastman Kodak. Aside from dividends collected over the years, the owners ended up with shares of a chemical company so the fact market capitalization went to zero didn’t mean they necessarily lost everything.
Using Market Capitalization to Build a Portfolio
A lot professional investors divide their portfolio by market capitalization size. These investors do this because they believe that it allows them to take advantage of the fact smaller companies have historically grown faster but larger companies have more stability and pay fatter dividends.
Here is a breakdown of the type of market capitalization categories you are likely to see referenced when you begin investing. Note that the exact definitions tend to be a bit fuzzy around the edges so make sure to pay attention to the specific methodology, especially when the methodology calls for manipulating the actual market capitalization figure for something called a float-weight adjustment, which even S&P 500 index funds have started doing in recent years.
- Micro Cap: The term micro cap refers to a company with a stock market capitalization of less than $250 million.
- Small Cap: The term small cap refers to a company with a stock market capitalization of $250 million to $2 billion.
- Mid Cap: The term mid cap refers to a company with a stock market capitalization of $2 billion to $10 billion.
- Large Cap: The term large cap refers to a company with a stock market capitalization of $10 billion to $100 billion.
- Mega Cap: The term mega cap refers to a company with a stock market capitalization of more than $100 billion.
Again, be sure to check the specifics when using these definitions. For example, a person might refer to a company with a stock market capitalization of $5 billion as being large cap under certain circumstances.
More Information About Stock Investing
For more information on stocks, read our Complete Guide to Investing in Stock.
How to Calculate Stock Market Capitalization and Why It Is Important Conclusion
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