Market Cap and Why Is It Important

Three Types of Market Cap

Apple iPhone 5C
•••

Lam Yik Fei/Getty Images

Market capitalization is the total value of a company. It's measured by the stock price times the number of shares issued. For example, a company that has 1 million shares that are selling for $10 each would have a market capitalization of $10 million. This means you could buy that company for $10 million if you had the money and all the current stockholders were willing to sell you their shares.

Market capitalization is usually called market cap for short. It also refers to the total value of a stock exchange. For example, the market cap of the Nasdaq would equal the market cap of all the companies traded on the Nasdaq combined.

Key Takeaways

  • Market capitalization is the total amount of money a company is valued in the stock market. 
  • The value of a company is calculated by the number of shares a company has times the price the stocks are selling at. 
  • Companies are separated into three different groups by investors depending on their market cap: small, medium, and large.
  • Small caps have greater room for growth, medium caps have room for growth and stability, while large cap companies have the most amount of stability.

Small, Medium and Large Cap

Investors, typically, use market cap to divide the stock market into three broad size categories.

Small cap companies have a market cap between $300 million to $2 billion. They are smaller companies, many of which recently went through their initial public offering. They are riskier because they are more likely to default during a downturn. On the other hand, they have lots of room to grow and could become very profitable. The smallest small caps, with market caps between $250-$300 million are called micro caps, where as those with market caps less than $50 million are often referred to as nanocaps.

Mid cap companies typically have a capitalization of between $2 billion to $10 billion. Such companies are typically in the growth phase of their business cycle, working towards expanding market share and increasing competitiveness. They can offer more growth potential than large cap companies and can carry less risk than small cap companies.

Large cap companies have the least risk because they typically have the financial resources to weather a downturn. Since they tend to be market leaders, they have less room to grow. The return may not be as high as small or mid cap stocks. On the other hand, they are more likely to reward stockholders with dividends. The market cap for these companies is $10 billion or more.

Market Cap Is a Good Way to Value Companies

Market cap is a relatively good way to quickly value a company. That's because stock prices are generally based on investors' expectations of a company's earnings. As earnings rise, stock traders will bid more for the stock price. Including the number of shares in the calculation offsets the impact of stock splits.

Market cap would be a great way to value companies if they all had the same price to earnings ratio. Investors consider some industries to be slow growing or stodgy. Their stock prices are undervalued, and so are the market caps of companies in that industry.

There are several other ways to determine the value of a company. One good way is to determine the net present value of its future cash flow or income. This gives the buyer an idea of what the return on investment will be. If a company's market cap is lower than the net present value of its cash flow, then it is undervalued, and a candidate for takeover.

Another more conservative approach is to determine the total resale price of all a company's assets. The drawback is that some assets would be difficult to value. Others may be worth more than their resale value. However, this is a good approach for a company that just wants to buy the company and sell off the assets for quick cash.

A company whose market cap was much lower than its resale value would be a target for this kind of takeover.

During the Internet bull market in 1999, many companies' capitalization values were worth far more than their income or asset value. Irrational exuberance drove stock prices beyond a reasonable valuation. When the tech bubble burst, it led to the recession of 2001. 

2021 Largest Companies by Market Cap

In 2018, Apple became the first company traded in the U.S. to cross $1 trillion in market capitalization and just two years later, it was the first to surpass the $2 trillion market cap milestone as well.

Here's a list of the top 20 largest companies traded in the U.S. by market cap as of May 10, 2021:

  1. Apple- $2.17 trillion
  2. Microsoft - $1.9 trillion
  3. Amazon- $1.66 trillion
  4. Alphabet (Google) - $1.60 trillion
  5. Facebook - $904.7 billion
  6. Berkshire Hathaway - $665.4 billion
  7. Tesla - $647.7 billion
  8. Alibaba - $610.7 billion
  9. Taiwan Semiconductor (TSMC) - $605.8 billion
  10. Visa- $495 billion
  11. JP Morgan Chase - $488 billion
  12. Johnson & Johnson - $443.7 billion
  13. Walmart - $394.4 billion
  14. United Health - $394.1 billion
  15. Mastercard - $372 billion
  16. Nvidia - $368.7 billion
  17. Home Depot - $364.7 billion
  18. Bank of America - $361.4 billion
  19. Walt Disney - $335.5 billion
  20. Proctor and Gamble- $330.8 billion

Most of these companies are all well-known, household names. Many have been on the top 20 list for years.