What is it?
Market capitalization, or market cap, denotes the aggregate value of the stock of any listed company. It is arrived at by multiplying the number of shares outstanding of a company with its current market price per share. For instance, if a company has 1,000 shares outstanding and its market share price is Rs 20 per share, then its market cap would be Rs 20,000. Reliance Industries Ltd is India’s largest company by market cap with 3,272.6 million shares and a market price of Rs 986.50 per share as on 21 January 2011 and, hence, a market cap of Rs 3.23 trillion. The total market cap of all companies listed on the Bombay Stock Exchange as on 21 January 2011 was Rs 68 trillion.
Categorization according to market cap
Companies can be broadly categorized through market cap in three ways—large-cap, mid-cap and small-cap. In the Indian context, a company that has a market cap of at least Rs 10,000 crore is considered a large-cap. Companies with a market cap of at least Rs 500 crore and less than Rs 10,000 crore are mid-caps and companies with a market cap of less than Rs 500 crore are generally referred to as a small-cap. Mid- and small-cap companies are perceived as riskier than large-cap companies.
Relevance of market cap
Market cap helps investors determine the value/size of the company (equity portion). Why is that relevant? Let’s understand through an example. If company A’s current share price is Rs 100 per share and it has 100 million shares outstanding. This means company A’s market cap is Rs 1,000 crore, putting it under the mid-cap category. However, if company B’s share price is Rs 50 and it has 10 billion shares outstanding, then company B’s market cap would be Rs 50,000 crore, categorizing it as a large-cap. Someone looking at just the market price would have thought company A was bigger.
What’s Its shortcoming
Though the market cap indicates the size of the company, it only tells us the value of the equity portion and does not include the debt component. Further, stock prices are also impacted by macroeconomic factors, which will eventually reflect in the market cap. For instance, when the financial crisis was at its peak, stocks of many financially healthy companies were hit badly, impacting their market caps.
So one can say it is a rough measure to figure out what the market thinks is the value of a particular company. Investors should avoid looking at market cap in isolation when analysing stocks.