What it means
When people say a company is "worth" a certain amount on the stock market, they are usually quoting its market capitalisation. The figure moves every time the share price moves, so it is a live reading of what investors collectively think the shares are worth.
It says nothing about what the company's assets cost or what its books show. The figure is used to group companies by size.
Analysts talk about large-cap, mid-cap and small-cap companies, and index providers use market capitalisation to decide membership and weighting of the main stock indices. The exact boundaries between the groups differ between providers and change over time.
Market capitalisation is not the same as the cost of buying the whole business. To take over a company, a buyer must also deal with its debt and cash, which is why enterprise value (market capitalisation plus debt less cash) is the better measure for acquisitions.
Two firms with the same market capitalisation can have very different enterprise values. The share count used should be the shares actually in issue, and some analysts prefer a diluted count that includes options and convertible securities likely to be exercised.
Some indices use only the free float, meaning shares available to the public and not held by founders or governments. Using the wrong count can change the figure by a significant margin.
For private companies there is no market capitalisation because there is no continuous share price. Investors use funding round valuations or comparable company multiples instead, and those figures are estimates rather than observed trading values.
In practice
Real-world examples
Example 1
A fund manager screens for listed companies with market capitalisation between $2 billion and $10 billion because her mandate covers mid-sized firms. A company whose share price jumps and takes it above $10 billion drops out of her investable list. She sells part of the holding.
Example 2
A founder preparing for a stock market listing asks bankers what the market capitalisation would be at the proposed price of $12 per share with 50 million shares. The answer is $600 million. He then compares it with similar listed companies to judge whether the price is reasonable.
Example 3
A supplier reading the news sees that a major customer's market capitalisation has halved in six months. It does not prove the customer is in trouble, but the supplier's credit team reviews payment terms and exposure. They shorten the payment window slightly as a precaution.
Think of it
Market cap is like the price tag on a company. It's what all the shares would cost if you bought the entire ownership stake at today's prices.
Formula
Calculation
Market capitalisation = Share price x Number of shares outstanding
Suppose a company has 40,000,000 shares outstanding and its shares trade at $25. Market capitalisation = 40,000,000 x 25 = $1,000,000,000. If the share price rises 10% to $27.50, the market capitalisation becomes 40,000,000 x 27.50 = $1,100,000,000, an increase of $100,000,000. If the company also has $300,000,000 of debt and $100,000,000 of cash, enterprise value at the original price = 1,000,000,000 + 300,000,000 - 100,000,000 = $1,200,000,000.Case study
Seen in the real world
Solaris Textiles is an illustrative, fictional manufacturer listed on a small exchange, with 25,000,000 shares in issue trading at $8. Its market capitalisation was therefore $200,000,000, and the board was pleased until a rival with a similar business announced a takeover bid for it at $10 per share.
The finance director calculated that the offer valued the equity at $250,000,000. Solaris also carried $90,000,000 of debt against $20,000,000 of cash, so the bidder was in effect paying an enterprise value of $320,000,000.
The board used both figures when negotiating, arguing that the premium over market capitalisation was only 25% and that the debt-inclusive price still undervalued the factories. The illustrative lesson is that market capitalisation is the starting point of a valuation conversation, not the end of it.
Watch out
Common mistakes
- Treating market capitalisation as the price to buy a whole company, when debt and cash also affect what an acquirer actually pays.
- Using the wrong share count, such as shares authorised rather than shares outstanding.
- Assuming a higher share price means a bigger company, when a firm with a low share price and many shares can be far larger.
Questions
People also ask
Is market capitalisation the same as book value?
No, book value comes from the balance sheet and reflects accounting records, while market capitalisation reflects the price investors are currently willing to pay for the shares.
Why does market capitalisation change every day?
Because it is share price multiplied by shares outstanding, and the share price moves with every trade, so the figure changes whenever the market's view changes.
Can a company have a negative market capitalisation?
No, a share price cannot fall below zero, although a company with heavy debt can have a negative equity book value while its shares still trade above zero.
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