You may have heard the term market cap (the short form for market capitalisation), and you may even have a vague understanding of how it relates to a company’s value.
But how do you determine what a company’s market cap is?
In this article:
- Determining value
- Micro-cap vs small-cap vs mid-cap vs large-cap
- Market cap does not always reflect equity value
Put simply, Market cap = share price x # of shares outstanding.
A company with 1 million shares selling for $7 each would have a market cap of $7 million.
The following video provides a great explanation of how market cap is determined:
Determining value
The first thing you notice about a company is usually its share price and trading chart.
However, a company’s share price doesn’t give you the full picture of a company’s worth.
While a stock represents ownership in a company, it is the market cap that indicates value and should give you your starting point to understand the relationship between company size, potential return and risk.
Another way to describe market capitalisation is the total dollar value of a company’s outstanding shares as determined by the stock market.
In other words, the market cap reflects what the market thinks a company is worth.
It is also important in that it provides a value comparison to similar companies and may also indicate to investors what the value of a company can be when compared to larger, more established businesses.
For instance, a small-cap company with a capitalisation of just $10 million that is conducting Phase 1 trials into a cancer treatment may aspire to the capitalisation of a billion-dollar-plus capped major pharma that has a product to market in the same field.
Market cap is initially established before a company lists on the stock exchange.
Investment banks will employ valuation techniques to determine a company’s value and the price and amount of shares on offer.
Once the company has completed its initial public offering (IPO), it is then traded on the exchange and its share price and market cap will fluctuate along with supply and demand.
The market cap will generally rise when a company has positive, market-moving news that points to future growth.
Bad news could see a market cap and share price crash. Of course, this is a generalisation, news doesn’t always determine movement, however, it can be a real-time estimate of the company’s value.
Micro-cap vs small-cap vs mid-cap vs large-cap
The market is broken into four categories: micro-cap, small-cap, mid-cap and large-cap.
When investing for the long term, it is always prudent to have a mix of companies that fall into these categories.
What is the value of companies in these categories?
Large-cap companies
Have a market cap of $10 billion or more.
These are mature companies in established industries that reward long term investors with a generally consistent increase in share value and dividend payments.
The top 10 largest companies by market cap include:
- BHP Group Ltd: $145.87 billion
- Commonwealth Bank: $119.7 billion
- Macquarie: $110.55 billion
- Transurban: $107.29 billion
- CSL: $99.47 billion
- Atlassian (NASDAQ:TEAM): $97.91 billion
- National Australia Bank Ltd: $66.92 billion
- ANZ Banking Group (ASX:ANZBY) Ltd: $55.61 billion
- Westpac Banking Group Ltd: $54.61 billion
- Wesfarmers Ltd (ASX:WES): $48.32 billion
Other large caps include Woolworths Group Ltd, Telstra Corporation Ltd (ASX:TLS) and Sydney Airport.
Large caps are benchmarked on the S&P/ASX 50, which contains the 50 largest companies on the Australian stock market.
Mid-cap companies
These are companies with a market cap between $2 billion and $10 billion and are well established in industries that are emerging and forecasting rapid growth.
They have outgrown the small-cap space but are too small to be considered large caps.
While there is a higher investment risk than large caps, the growth potential can be appealing for investors.
ASX listed companies in the mid-cap space include:
- Wise Tech Global: $16.73 billion
- Domino’s Pizza: $14.22 billion
- Qantas Airways (ASX:QAN): $10.24 billion
- Medibank Private: $9.72 billion
- Oil Search: $7.49 billion
Mid-caps are benchmarked on the S&P/ASX Mid Cap 50, which comprises members of the S&P/ASX 100, excluding companies in the S&P/ASX 50.
Small-cap/micro-cap companies
Are often classified together and may also be called penny stocks.
However, micro caps are generally considered to be worth between $50 million and $300 million, while small caps have a value in the range of $300 million to $2 billion.
These tend to be young, emerging companies that are considered higher risk investments, but have excellent growth value.
They are more volatile and less liquid than larger companies. If they are a mining company, they may be in the early exploration phase rather than in production, or if they are biotech or tech, they may be in the trial or development phase rather than the commercial sales phase.
Small/micro-cap companies include:
- AdAlta Ltd (ASX:1AD): $19.84 million
- Galileo Mining Ltd (ASX:GAL): $36.21 million
- Chimeric Therapeutics Ltd (ASX:CHM): $58.37 million
- Euro Manganese Inc (ASX:EMN, TSX-V:EMN, OTCQX:EUMNF) CDI (NYSE:CDI): $170.19 million
- Vulcan Energy Resources (ASX:VUL) Ltd: $1.39 billion
Small-cap companies are benchmarked on the S&P/ASX Small Ordinaries index (XSO), which represents the smaller members of the S&P/ASX300 index.
Market cap does not always reflect equity value
While market cap is a great way to understand a company's general value, only by doing a thorough analysis of a company’s fundamentals can you determine true equity value.
Fundamentals include information such as profitability, revenue, assets, liabilities and growth potential.
It takes into account macroeconomic and microeconomic factors.
Inflation, supply and demand, monetary and fiscal policy can also have a say in a company’s value.
True analysis requires qualitative and quantitative analysis – a topic for another time.
Suffice to say a company’s true value is determined by so much more than a market capitalisation
However, the market cap is a great place to start when looking at a company’s value.