Market Capitalisation: Meaning, Formula and Types

In February 2024, Nvidia's market capitalisation surged by 16% in a single day, adding an incredible US$277 billion. This single-day increase exceeded the total market capitalisation of India's largest company, Reliance Industries, which was around US$240 billion. This highlights the significant impact of market capitalisation. So what is market cap, and why is it important? Check out this blog to get answers to this question and more on this topic. 

What is Market Capitalisation?

Market capitalisation, more commonly known as market cap, represents a company's total value based on the current market value of its shares. It is calculated by multiplying the current share price by the total number of shares available.

Market cap helps gauge the size and stability of a company by providing a snapshot of the company’s worth in the eyes of the market or the market value compared to its peers. 

Analysing a company's market capitalisation is an important metric as it can influence its ability to attract investors, secure financing, and expand operations.

Companies are often classified based on their market capitalisation into large-cap, mid-cap, and small-cap companies on the stock exchanges. They can influence investment strategies for investors based on their risk-return perceptions. 

Market Capitalisation Formula

Market capitalisation is a product of the number of shares and the current market price. The formula for market capitalisation is -.

Market Capitalisation = Current Share Price * Total Number of Outstanding Shares

Let us understand the calculation of market capitalisation using the following example. 

Consider Reliance Industries Ltd., which has a total number of outstanding shares of 6,76,62,29,009 and a current share price of Rs.3051.95 as of 30th August 2024. The market capitalisation calculation in this example is explained below.

Market Capitalisation = Current Share Price * Total Number of Outstanding Shares

Market Capitalisation = 3,051.95 * 6,76,62,29,009 = Rs. 20,65,019 Crores

Importance of Market Capitalisation

Here are some factors that make market capitalisation an important metric to be considered by investors.

Measuring Company Size

Large-cap companies with a higher market capitalisation are usually well-established and stable, while mid-cap and small-cap companies offer more growth potential but have higher risks. Therefore, knowing a company's market cap helps investors assess its scale and maturity.

Investment Strategy

Market capitalisation can also be a parameter for shaping investment strategies. Large-cap stocks are often considered safer and more reliable, suitable for conservative investors. In contrast, small and mid-cap stocks can be attractive to those seeking higher returns and are willing to take on more risk.

Comparing Companies

Market cap provides a straightforward way to compare companies within the same industry or sector. Investors can use the market cap to better understand a company's overall value and position relative to its peers rather than solely looking at share prices. 

Impact on Fundraising and Expansion

A higher market cap can make it easier for companies to raise funds. Investors are more likely to invest in companies with high market caps, believing they are stable and have growth potential. This increased ability to raise funds can support expansion, research, and development, driving further growth and success.

Risk Assessment

Understanding market cap helps in assessing investment risks. Larger companies with higher market caps tend to be more resilient during economic downturns, while smaller companies might be more vulnerable to market fluctuations. Investors can use this information to balance their portfolios according to risk tolerance.

Influencing Market Indices

Market cap is a key factor for inclusion in stock market indices like the BSE Sensex and Nifty 50. 

Categories of Market Capitalisation

Market capitalisation is a measure for classifying companies based on their size and scale on a stock exchange. The categories of market capitalisation in the Indian stock exchanges are -

Large-Cap

Large-cap companies are the top 100 companies in India in terms of market capitalisation which can be Rs. 20,000 crore or more. These companies are typically well-established and financially stable, often being industry leaders. They offer steady returns and are considered less risky investments, making them suitable for conservative investors.

Mid-Cap

Mid-cap companies are companies ranked 101st to 250th in terms of market capitalisation which can range between Rs. 5,000 crore and Rs. 20,000 crore. They are usually in the growth phase and have the potential for higher returns compared to large caps. However, they also come with higher risk, as they are less established than large-cap companies.

Small-Cap

Small-cap companies are companies ranked 251st and onwards in terms of market capitalisation which is usually less than Rs. 5,000 crore. These companies are often young and have significant growth potential. While they can offer substantial returns, they are also more volatile and risky, making them suitable for investors with a higher risk tolerance.

What are the Factors that Impact Market Capitalisation?

The factors that influence the market capitalisation of a company are:

• The company’s financial performance can significantly affect its stock price and market cap.

• Changes in investor perceptions and market sentiment can cause stock prices to rise or fall, impacting the market cap.

• Macroeconomic factors like interest rates, inflation, and overall economic stability influence market confidence and a company's market cap.

• Industry trends and competition changes can affect a company's market position and stock valuation.

• Government policies and regulatory changes can affect a company's operations and profitability, influencing its market cap.

Limitations of Market Cap

Market capitalisation is the absolute measure of a company's size. However, this measure alone can provide limited insights to make informed investment decisions. The limitations of using market cap are -

• Market Sentiment Driven: Market capitalisation can be heavily influenced by investor sentiment and market trends, leading to overvaluation or undervaluation of a company’s stock.

• Not a Comprehensive Measure:  Market capitalisation only reflects the value of a company's outstanding shares and does not account for debt or other liabilities, which can give an incomplete picture of a company's financial health.

• Provides a Static Snapshot: It gives a snapshot at a specific time and may not accurately represent a company’s value over the long term, especially in rapidly changing industries.

• Susceptible to Manipulation: Market capitalisation can be susceptible to manipulation through stock buybacks or artificial inflation of stock prices, misleading investors.

• Ignores Business Fundamentals:  Market capitalisation does not consider important factors like a company’s earnings, revenue, and growth potential, which are crucial for assessing long-term value.

Conclusion

Market capitalisation is a crucial metric for understanding a company's size, stability, and market value. It helps investors compare companies, shape investment strategies, and assess risks. However, due to its limitations, it cannot be used as a standalone measure of a company's viability and growth prospects. Therefore, investors should use market capitalisation along with a fundamental analysis of the company for optimum evaluation and making informed decisions.