Market capitalization definition
Market capitalization, commonly referred to as market cap is referred to as the amount of money required to buy all the shares of a company at current market valuation.
It is a factor that divides the companies into large cap, mid cap and small cap. It is also the factor on which the weightage of the company in the index like Nifty or Sensex is determined.
How to calculate market cap of a company
Market cap is calculated by multiplying the total shares of the company by the current market price it is trading on.
Mathematically it can be expressed as:
Market cap = Total no of shares X Current market price
For example, if the total number of a shares of a company are 25 lakhs and the current market price of each share is Rs. 100, then the market cap of that company will be Rs. 25 crores.
How can we compare companies with market cap
Based on the market cap, the companies are divided into the following categories:
- Large cap companies
- Mid cap companies
- Small cap companies
|Sr No||Type of stock||Company position||Market capitalization|
|1||Large cap||Top 100 stocks||More than Rs. 5000 crores|
|2||Mid cap||Next 200 to 500 stocks||From Rs. 500 to 5000 crores|
|3||Small cap||The remaining stocks||Less than Rs. 500 crores|
- Large cap companies are also called blue chip companies. Due to the large size of their market cap they are attracted by many institutional investors. They enjoy a high level of liquidity.
- Mid cap companies are those that have a lower market cap than the large cap companies, but have an appropriate level of liquidity.
- Small cap companies usually have a low market cap, as a result they do not have much liquidity.
Why is market cap the right way to track company’s growth
Analyzing a company just on the basis on the returns on the stock price may not be the right way to scale the performance of the company. It may not be evident in the charts that stock has undergone a stock split or rights were issued. In this scenario scaling the company using the market cap is more feasible.
One of the things I do after investing in a stock is that I note down the market cap of the company on the date I have purchased the shares.
The value of stocks can change due to splits, bonus and rights issues. Hence analyzing the company using its share price may not be the right way to look at company’s valuation.
Factors that influence the market capitalization of a company
The price of a stock is directly proportional to the market capitalization. A substantial increase in the price of a stock will result in the rise of the market cap of that company.
Another important factor directly influencing the market cap of the company is the number of shares. Company can go for stock splits, bonus and rights issues and create more shares of the company, influencing the market capitalization
Two companies can merge together as one company and treat the stocks of both the companies as one entity. In that scenario, it is ideal that the market cap of the company can be influenced.
Example of Wipro Ltd.
One of the classic example that comes to my mind when I hear companies expanding with market cap is Wipro. The share price of Wipro has escalated from Rs. 100 to Rs. 500 in the last 30 years. But if you had invested Rs. 10000 in 1980, today its value would be more than 700 crores.
It is surprising for new investors to see that the price just moved 5 times but the investment grew exponentially.
You can read this blog by Get Richer and see exactly how the price of Wipro rose from Rs. 10000 to more than 700 crores in 40 years with the exact dates of stock splits and bonus issues.
Analyzing the market cap of a company is an important parameter to study the performance of the company’s growth. It is crucial to see how has the market cap of the company grown over time and at what rate.
Personally, I study all the companies in a particular sector by doing a comparative analysis on their market cap. Take for example if I see a great scope in the future for banking and finance sector. I write all the companies in that sector and see their market cap performance.
A company with a higher market cap are usually more of a stable growth company and there are not much chances for the company to grow further. This can be ideal for low risk investor who want to play it safe with their investment.
While companies with a low market cap can have a potential for growth in the future. This can be taken up by high risk investors.
One thing to note is that if a company with a stock trading at Rs. 1000 can have a low market cap and a company with stock trading at Rs. 50 have a higher market cap. So not all expensive stocks are good and not all cheap stocks are bad.
One more thing to note is that a company with a low market cap may not necessarily go big or a company with high market cap refuse to expand further. There are many other factors that determine the growth of the company over time and market cap is one of the financial factors that should be looked at before investing.