Market Capitalization

Market capitalization is one of the best measures of a company's size. Also known as market cap, market capitalization is the total market value of a company's outstanding shares of stock. For example, you may have heardApple referred to as "the most valuable company in the world." That's because Apple currently has the highest market cap of any publicly traded company.

Let's go over how to calculate this metric and what it means for investors.

Calculating market capitalizationTo calculate market capitalization, simply take the total number of a company's shares outstanding and multiply that figure by the stock's market price. If a company has 2 million shares outstanding and each share is worth $20, then its market capitalization is $40 million.

A company can issue new shares of stock to increase its market capitalization. Note that a stock split won't affect a company's market capitalization, even though it will increase the total shares outstanding. The reason is that when stocks are split, their individual prices are split by the same proportion. If a company has 30 million shares outstanding worth $10 each, after a 2-for-1 split, it will have 60 million shares outstanding worth $5 each. Either way, the product of that company's shares outstanding multiplied by its stock price will be the same, and so its market cap will not change.

Tiers of market capitalizationThere is no universally agreed-upon way of categorizing companies based on their market cap, but they are often categorized as follows:

Mega-cap companies have a market cap in excess of $200 billion
Large-cap companies have a market cap of $10 billion to $200 billion
Mid-cap companies have a market cap of $2 billion to $10 billion
Small-cap companies have a market cap of $300 million to $2 billion
Micro-cap companies have a market cap of $50 million to $300 million

Understanding how a company is classified can help you make smart investment decisions. Large-cap companies generally have more assets and capital than small-cap companies, and as such, they're typically considered to be a lower-risk investment than small-cap companies. On the other hand, small-cap companies may have greater growth potential than large-cap companies, and as such they could provide a good opportunity for capital gains.

Market capitalization versus stock priceThe price of an individual share of stock doesn't tell us how much its issuing company is worth overall; it simply tells us the going rate to buy a piece of that company. While some might assume that the higher a company's stock price, the larger it is, this isn't always the case. It's possible for a company with a lower stock price to have a larger market cap than one with a higher stock price. In this regard, market capitalization is a good measure of a company's overall size, and it can also help investors compare companies whose stocks are similar in price.

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