I constantly hear the terms "small cap" and "large cap" while watching the financial channels on TV.
What is meant by small/large market cap?
How do they relate to a stock valuation?
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.Sign up to join this community
Market Capitalization is the equity value of a company. It measures the total value of the shares available for trade in public markets if they were immediately sold at the last traded market price. Some people think it is a measure of a company's net worth, but it can be a misleading for a number of reasons.
Share price will be biased toward recent earnings and the Earnings Per Share (EPS) metric. The most recent market price only reflects the lowest price one market participant is willing to sell for and the highest price another market participant is willing to buy for, though in a liquid market it does generally reflect the current consensus. In an imperfect market (for example with a large institutional purchase or sale) prices can diverge widely from the consensus price and when multiplied by outstanding shares, can show a very distorted market capitalization.
It is also a misleading number when comparing two companies' market capitalization because while some companies raise the money they need by selling shares on the markets, others might prefer debt financing from private lenders or sell bonds on the market, or some other capital structure. Some companies sell preferred shares or non-voting shares along with the traditional shares that exist. All of these factors have to be considered when valuing a company.
Large-cap companies tend to have lower but more stable growth than small cap companies which are still expanding into new markets because of their smaller size.
Market capitalization is one way to represent the value of the company. So if a company has 10 million shares, which are each worth $100, then the company's market capitalization is 1 billion.
Large cap companies tend to be larger and more stable. Small cap companies are smaller, which indicates higher volatility. So if you want more aggressive investments then you may want to invest in small cap companies while if you lean on the side of caution then big cap companies may be your friend.
Market Capitalization is the value the market attributes to the company shares calculated by multiplying the current trading price of these shares by the total amount of shares outstanding. So a company with 100 shares trading at $10 has a market cap of $1000.
It is technically not the same as the value of a company (in the sense of how much someone would need to pay to acquire the company), Enterprise value is what you want to determine the net value of a company which is calculated as the market capitalization + company debt (as the acquirer has to take on this debt) - company cash (as the acquirer can pocket this for itself).
The exact boundary for when a company belongs to a certain "cap" is up for debate. For a "large cap" a market capitalization of $10 billion+ is usually considered the cutoff (with $100+ billion behemoths being called "mega caps"). Anything between $10 billion and ~$1 billion is considered "mid cap", from ~$1billion to ~$200 million it's called a "small cap" and below $200 million is "nano cap".
Worth noting that these boundaries change quite dramatically over time as the overall average market capitalization increases as companies grow, for example in the 80s a company with a market cap of $1 billion would be considered "large cap".
The market "determines" what the market cap of company should be based (usually but certainly not always!) on the historical and expected profit a company makes, for a simple example let's say that our $1000 market cap company makes $100 a year, this means that this company's earnings per share is $1. If the company grows to make $200 a year you can reasonably expect the share price to rise from $10 to ~$20 with the corresponding increase in market cap. (this is all extremely simplified of course).
Market Capitalization is the product of the current share price (the last time someone sold a share of the stock, how much?) times the number of outstanding shares of stock, summed up over all of the stock categories.
Assuming the efficient market hypothesis and a liquid market, this gives the current total value of the companies' assets (both tangible and intangible).
Both the EMH and perfect liquidity may not hold at all times.
Beyond those theoretical problems, in practice, someone trying to buy or sell the company at that price is going to be in for a surprise; the fact that someone wants to sell that many stocks, or buy that many stocks, will move the price of the company stock.