Use Market Cap When You're Considering Stocks

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When you're evaluating a publicly-traded company and deciding whether you want to purchase some of its stock, you shouldn't focus solely on the price of one share. Make sure you look at its market capitalization, or "market cap," to get a clearer picture of how the market values the company.

The market cap represents the amount you would pay to buy up all of the company's shares, not necessarily its true value. The size of a business's market cap determines the broad category of publicly traded company it falls under—small-cap, mid-cap, or large-cap.

Learn what market cap can tell you about a company and why you should use it when evaluating a one.

What Is Market Cap?

Market cap is the number of outstanding shares multiplied by the current share price. The result tells you the value of a company's stocks on the stock market. It is calculated using the float method or the free-float method.

Float is the number of shares a company has that are outstanding and owned by the public investors. The free-float method doesn't count shares held by executives, a government, or some other private party whose stake is not traded on the market.

Most stock market indexes use free-floating market caps. The Dow Jones Industrial Average and the Standard & Poor's 500 Index are two of them.

Market cap is a company's size on the stock market. If the stock market's total value is $49 billion, and a business has $12.25 billion in outstanding shares, its market cap is one-quarter of the stock market.

Consider these two companies with very different stock prices yet somewhat similar market caps:

Company 1:

  • Stock price: $50
  • Outstanding shares: 50 million
  • Market cap: $50 x 50,000,000 = $2.5 billion

Company 2:

  • Stock price: $10
  • Outstanding shares: 300 million
  • Market cap: $10 x 300,000,000 = $3 billion

If you looked only at their per-share prices, you wouldn't know the second company was the more highly valued of the two. No two investors share the same thoughts on value, because everyone is unique. However, the second company has more shares issued. That means that overall, investors value its shares more highly than those of the first company.

Market Cap Systems

When you're evaluating companies, market cap helps you compare similar businesses. The criteria for small-, mid-, and large-cap companies differ. They also change as the overall market waxes and wanes. Here is an example system:

  • Small-Cap: under $1 billion
  • Mid-Cap: $1 billion to $10 billion
  • Large-Cap: $10 billion or more
© The Balance 2018

On March 17, 2021, Standard & Poor's (S&P) started using these market-cap limits and ranges for its large-, mid-, and small-cap indexes.

  • S&P 500: at least $11.8 billion
  • S&P MidCap 400: $3.3 billion to $11.8 billion
  • S&P SmallCap 600: $750 million to $3.3 billion

Some firms and analysts add micro-caps and mega-caps—the smallest and biggest publicly traded companies—to the mix.

In general, small-cap stocks have greater potential for price growth, because the companies themselves still have room to grow. However, they may also be riskier investments, because future performance is always unknown.

Large-cap stocks have less growth potential but are thought to be safer investments because of their longer success records. Mid-cap stocks typically fall between small caps and large caps for their growth and safety guidelines.

Market Cap vs. Enterprise Value

A company's market cap can also be called its "equity value." The market cap considers only the value of its shares. Enterprise value is a broader way of gauging a company's worth.

To calculate a company's enterprise value, you add its market cap to the value of its outstanding preferred shares (if any) to any minority interest in the company (if any). Then, add in the market value of its debt and subtract its cash and equivalents.

The cash and equivalents are subtracted out, because if you were to buy the company, you would take that money. Therefore, it shouldn't be included when arriving at a theoretical takeover price for the company.

You can use enterprise value instead of market cap in common metrics for evaluating companies. Some examples are price-to-earnings and price-to-sales ratios. Doing so may help you more accurately determine the worth of companies with large cash holdings.

The Balance does not provide tax or investment advice or financial services. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.

Frequently Asked Questions (FAQs)

Why is market cap important?

Market cap is an expression of the total value of a company on the open market—it demonstrates what it's worth to investors. It also gives you an indication of the size of a company and its operations. These factors help you assess the potential risk and return involved in investing in a company.

How does market cap affect stock price?

Market cap doesn't directly affect a company's share price, since market cap is simply the company's total outstanding shares multiplied by its share price. However, since market cap reflects a company's perceived value in the eyes of investors, this can still drive up the share price over time.