How to Calculate Stock Market Capitalization and Why It Is Important
What's that company worth?
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 and used in financial textbooks, you may not know how stock market capitalization is calculated. You may also be confused as to how it differs from the figures that arise in discussions of mergers and acquisitions. Luckily, the concept is fairly straightforward and easy to learn.
The Definition of Stock Market Capitalization
Put simply, stock market capitalization is the amount of money it would cost you 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. Unlike other financial data points, there are no hidden tricks, weird quirks, or jargony concepts to consider. You only need two pieces of data, the number of shares outstanding and the current stock price. Once you have the data, it's this straightforward:
The stock market capitalization is the current shares outstanding multiplied by the current stock market price.
An Example of How to Calculate Stock Market Capitalization
As of October 25, 2019, The Coca-Cola Company [NYSE: KO] has roughly 4.28 billion shares of stock outstanding, and the stock traded at $53.75 per share. If you wanted to buy every single share of Coca-Cola stock in the world, it would cost you 4,280,000,000 shares x $53.75, or $230,050,000,000. That is more than $230 billion. On Wall Street, people would refer to Coca-Cola's market capitalization as roughly $230 billion.
The Strengths and Weaknesses of Stock Market Capitalization
Stock prices can sometimes be misleading when comparing one company to another. Stock market capitalization, on the other hand, ignores capital structure specifics that can cause the share price of one firm to be higher than another. This allows investors to understand the two companies' relative sizes. For example, compare Coca-Cola at $53.75 per share with streaming service Netflix at $276.82 per share. Despite having an exponentially larger share price, the latter has a stock market capitalization of roughly $121 billion, more than $100 billion smaller than Coke's. This illustrates some of the complications that come with how to think about share price. Sometimes, 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. At the end of 2018, the company had around $29.2 billion in current liabilities (debt, taxes, etc.). If were you to buy the entire business, you would be responsible for servicing and repaying all those liabilities. That means, while Coke's stock market capitalization is $230 billion, it's enterprise value is $259.2 billion. All else being equal, the latter figure is what you would need to not only buy all of the common stock—but pay off all the company's debt, too. Enterprise value is a more accurate indicator of 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 distributions such as spin-offs, split-offs, or dividends, which are extremely important in calculating a concept known as the "total return." It seems strange to many new investors, but the total return can result in an investor making money, even if the company itself goes bankrupt. For one, you may have collected dividends over the years. The company could also get bought out, and your shares could be bought outright or transferred to shares in the new parent company.
Using Market Capitalization to Build a Portfolio
Many professional investors divide their portfolio by market capitalization size. These investors do this because they believe it allows them to take advantage of the fact that smaller companies have historically grown faster, but larger companies have more stability and pay more in dividends.
Here is a breakdown of the type of market capitalization categories you are likely to see referenced when you begin investing. The exact definitions tend to be a bit fuzzy around the edges, but this is a pretty good guideline.
- 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 or very large 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, an analyst might refer to a company with a stock market capitalization of $5 billion as being large cap, depending on the circumstances.
More Information About Stock Investing
For more information on stocks, read the Complete Guide to Investing in Stock.