Market capitalization in simple words

Long-term investment strategies require investors to take a comprehensive approach and carefully evaluate companies. Market capitalization is an indicator that helps determine the company's size, return potential, and risks. Understanding this term is important for an investor who wants to make informed decisions and build a diversified portfolio.

 

What is market capitalization? What formula is used to calculate it? Why is this metric important for investors? We answer these questions in the article.

 

Definition of market capitalization

Market capitalization (market cap) is an indicator of the total value of a public company, which is estimated by investors on the stock market. It is calculated by multiplying a company's current share price by the total number of shares outstanding.

 

 

Market capitalization is not always equal to the real intrinsic value of the company, because for the most part capitalization depends on supply and demand in the market. To estimate the real value of a company, an investor must consider many other factors such as debts, profitability, and dividend payout.

 

With the help of market capitalization, an investor can determine the size of a company, which allows one to assess its growth potential and sustainability. According to this indicator, companies are usually divided into three main categories: large-cap, mid-cap, and small-cap.

 

Large-cap companies

 

This category includes companies with more than $10 billion market capitalization. They often have a good reputation, stable profitability, and significant experience. These companies mostly operate in established and sustainable markets and dominate in their industry.

 

Investments in large-cap companies are considered the least risky, so they are often chosen by conservative investors. They are characterized by stable dividend payments and slow and insignificant growth of shares.

 

Mid-cap companies

 

The market capitalization of companies in this category ranges from $2 to $10 billion. These may be new companies that are in the active development stage or companies in industries that are expected to grow rapidly soon.

 

Mid-cap companies are usually riskier than large-cap companies, but the first ones have more opportunities for growth and expansion.

 

Small-cap companies

 

Companies in this category have a market capitalization of less than $2 billion. They most often operate in market niches and new industries.

 

Investing in these companies is the riskiest because of the high volatility of their shares. Despite this, they can offer more growth potential than large-cap and mid-cap companies.

 

 

Importance of market capitalization to investors

 

Although market capitalization does not reflect a complete picture of a company's real value and condition, it is an important metric to consider when building an investment portfolio.

 

1) Managing risks. Market capitalization can help investors assess the risk associated with investing in a particular company. Generally, stocks in small-cap companies are more volatile and high-risk.

 

2) Creating an investment strategy. Investors who prefer stability and consistent income may target large-cap stocks, while those looking for higher growth potential may prioritize small-cap stocks.

 

3) Diversifying a portfolio. To balance an investment portfolio, one can include stocks of companies with different market capitalizations. This helps to spread risks and capitalize on opportunities in different market segments.

 

4) Analyzing performance. Market capitalization allows investors to compare the performance of stocks in the same category. Tracking the performance of companies with different capitalizations can provide insights into market trends and investment opportunities.

 

Conclusion

 

Market capitalization is an important metric for investors who analyze the market, evaluate companies, and build investment portfolios. By understanding the different categories of companies, their potential, and possible risks, investors can make informed decisions and develop long-term strategies. Understanding market capitalization and other important aspects of the stock market helps investors achieve financial goals and create balanced investment portfolios.