Market Capitalization

Market capitalization is the market value of a company's shares (which are outstanding) in total. Investors substitute sales or total assets for market capitalization to determine the size of the company. The value of the company is difficult to estimate. It is an important and complex problem. Market capitalization helps in solving it. This indicator gives an idea of whether the company is valuable for a takeover or not.

Understanding Market Capitalization

Quickly and easily estimating the value of a company can be done through the market capitalization. To get this indicator, you need to extrapolate the market value for publicly traded companies. This means multiplying the share price by the amount of existing shares.

When a company goes public, it goes publicly traded. The demand and supply of its shares on the market determine the price of that company. Under favorable conditions, the demand for a company's stock is high. The higher the demand, the higher the price. If potential growth is not expected, the price of the company's stock may be lowered by sellers. So, it turns out that market value is an estimation of a company's value in real time.

For example, the value of the stock of two different companies is $100 and $200. The second company is not twice as big as the first. It is necessary to analyze the securities and the total market value, as well as to take into account the number of issued shares.

How to calculate Market Cap

There is a formula to calculate the market capitalization.

For example, one company's shares cost $100 each. The company has a total of 20 million such shares. As a result, the market value of such a company is $2 billion. The shares of the second company cost $1,000 each. The second company has a total of 10,000 such shares. The market value of the second company is $10 million.

Companies that want to go public apply to investment banks. They, in their turn, can use valuation methods to determine the value of the company. In the same way, it is possible to determine the number of shares and their value. The initial public offering (IPO) determines the market capitalization of the company.

For example, an investment bank has determined the value of a company's IPO. It was $100 million. The company can issue 10 million shares for $10 or 20 million shares for $5. In both cases, the initial market value would be $100 million.

Market Cap and investment strategy

Market capitalization is quite a simple and effective risk assessment. It can help determine which stocks are interesting and how to diversify a portfolio with companies of different sizes.

Large companies are those that have been on the market for a long time and have a reputation for stability in their industries. The market capitalization of large companies is $10 billion or more. These companies typically do not generate quick returns for their investors, but in the long run they have a steady increase in shareholder value and dividend payments.

Mid-sized companies are those that are well-established in their industry and expect quick growth. Mid-cap companies have a market capitalization of $2 billion to $10 billion. They are growth companies with higher risk than large companies. They are not yet as well-established in the market, but they are promising and are attractive to investors.

Small companies’ capitalization ranges from $300 million to $2 billion. Typically, small companies serving narrow markets are younger and operate in new industries. Investing in such companies is considered risky because they are young and small companies with less resources. They are more affected by negative economic downturns.

More stable and larger companies have stock prices that are less volatile and more liquid than smaller companies. But large companies have fewer growth prospects than small companies.

Micro companies with valuations between $50 million and $300 million also exist.

Diluted Market Cap

The number of outstanding shares affects the market capitalization of a security. Cryptocurrencies are particularly affected because of the frequent issuance of new tokens or coins.

New offerings can reduce the value of existing coins, tokens, or shares. To calculate the potential market capitalization when authorized shares or tokens are issued and keep their prices down, a different formula can be used. This calculation is called diluted market value. The formula is shown below:

As of mid-August 2022, the cost is $24,000 per Bitcoin. The number of issued bitcoins has reached approximately 19.1 million. The total number of bitcoins that can be issued is 21 million, which means that the market value of bitcoin can be calculated as follows:

Market Cap = $24,000 * 19.1 million = $458.4 million

Diluted Market Cap = $24,000 * 21 million = $504 million

The diluted market cap gives an indication of potential changes in the price of a security, token or coin. For example, if all 21 million bitcoins were mined, the price would have to drop to about $21,828 ($458.4 million / 21 million) to maintain the same market value of $458.4 million. From this it can be concluded that the large stock of unissued securities or coins exposes the company to the risk of a severe price drop. This is necessary to preserve the market value of the company, regardless of the number of tokens issued.

Misconceptions about Market Caps

A company's equity cannot be measured by market capitalization, but it is often used to describe a company. Only by analyzing the fundamentals is it possible to understand the value of a company's equity capital. It is based on market price, which does not always show the value of this or that part of the business, so it is an inadequate indicator. The market can overvalue or undervalue a stock. It only reflects the price the market is willing to pay.

The market price measures the purchase price of all the shares of a company, but it does not determine the price for which a company can be acquired in a merger. The enterprise value will show the purchase price of the company more accurately.

Changes in Market Cap

The company’s market value can change under the influence of two factors. One is the issuance or repurchase of shares by the company, and the other is changes in the price of the shares. By selling a large number of warrants, an investor can also quantitatively increase shares on the market. This will have a negative influence on shareholders in the dilution process.