Market capitalization is the value of a public company's tradable shares, and equals the share price times the number of outstanding shares. Here is an overview of how market capitalization factors into financial investments.
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Calculating market capitalization
Calculating market capitalization is a straightforward process: multiply the stock price by the number of outstanding shares. It provides a valuable preliminary idea but is by no means definitive or thorough.
"It gives you a starting point, an impression, for the value of a company," said Ty J. Young, president and CEO of wealth management firm Ty J. Young Inc.
Market capitalization can also be used to measure a company's worth in relation to other companies.
Young continued, "It is a gauge for the regular players in the marketplace, and therefore investors and those in the business community can trust that other participants are using that valuation in their measurement of a company's worth."
Market capitalization is divided into different categories to give people a quick approximation of a company's size. Although definitions for these categories are not definitive, they can prove helpful for a general impression. Generally, the three main categories investment managers use are large, medium and small cap. However, as markets have grown, other phrases like mega, micro and nano cap have cropped up to describe the wider spectrum of companies that trade publicly.
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According to David Abuaf, chief investment officer at Hefty Wealth Partners, "Mega is defined as ultra large cap." He said the rule of thumb is if the market capitalization is greater than $200 billion dollars. Apple (AAPL), General Electric (GE) and ExxonMobil (XOM) are well-known mega caps, with market caps of $556 billion, $212 billion and $407 billion, respectively.
Abuaf explained that micro means small cap and designates operating profits ranging between millions to tens of millions. Nano designates extremely small caps, with operating earnings between thousands or hundreds of thousands of dollars, or even negative operating earnings.
Relevance to mutual funds
When screening for new investment opportunities, mutual funds often use the market capitalization of a company. Mutual funds might have a mandate to purchase stocks from a large, medium or small cap company, but Abuaf reiterated, "It's important to keep in mind that one mutual fund's definition of market cap category is often different than another mutual fund's."
Limitations of metric
Young said market capitalization doesn't address many issues, such as a company's books, hiring strategy, management experience, new products coming online, pending legal actions, price-to-earnings ratio and so on.
"Market cap is a snapshot, and trading information is fluid. Once you see the snapshot, time has moved past it, so it does not have a forward-leaning benefit," he said.