If we look at the graph above, we see that in 2006 and in 2011, Exxon Mobil was the topmost company according to market cap calculations; however, in 2016, its not so. Whereas, Apple was a very small company in 2006. In 2016, Apple became the largest market cap company. Likewise, do have a look at Amazon, it was smaller than Apple at that point in time. However, the market cap of Amazon is now very very close to that of Exxon.

In this article, we will learn what is market capitalization and its meaning in detail

Market Capitalization is an important concept to the investors who are looking for investing in company shares. Usually, each investor looks at the market capitalization of a company before deciding to invest in the firm. Market capitalization means market cap in short. There are three types of companies which investors have an option to invest in small cap, medium cap, and large cap. We will discuss them in detail in the later section. For now, its important to know that each type of investors has a different outlook and different perspectives about these 3 types of companies.

In simple terms, the meaning of market cap is the value of the company in the market and market cap calculation is based on the market value of theoutstanding shares of the company in the market.

For example, if the market value of the outstanding shares of Company X is the US $100,000, then the US $100,000 would be the market cap of Company X.

The market cap formula is simple. Heres the formula

Market Capitalization formula = Outstanding shares * Market Price of each share

There is always confusion between market cap andequity value of the company. But market capitalization is not the equity value of the company.Market capitalization calculation is based on market price; whereas, equity value is calculated on the basis of book value.

Most investors get busy buying stocks of other companies depending on the market capitalization of those companies. But there is a flaw which we need to look at.

Market capitalization cant be the sole domain of valuation of a company. That means market capitalization doesnt equal to the takeover value of the firm. So its flawed. Whats important for investors to consider is to understand enterprise value when they want to go ahead and buy the stocks or invest in the said company.

Heres why enterprise value is given a higher rating than market capitalization.

First, enterprise value takes into account the total debt and cash & cash equivalent of the company which market capitalization doesnt take into account. That means if we look at enterprise value, we would understand the takeover value of the company. Have a look at the formula of enterprise value of the company to understand this clearly

Enterprise Value = Market Capitalization + Total Debt Cash

Many analysts take preferred stocks and many current assets into account to provide a more accurate figure ofenterprise value.

Second, if we take only market cap into account, we would miss out on the takeover value of the firm. For example, if Company A and Company B both have similar Market Cap. And Company A doesnt have any debt but some cash and Company B have a lot of debt and no cash, the takeover value would be completely different from the investors.

So, if you want to consider market cap calculation as the sole domain, think again. You may be missing out on the total debt and cash of the company which you need to take into account.

also, look atMarket Cap vs Enterprise ValueandEquity Value vs Enterprise value

Market Cap is an important concept. But as mentioned in the above section, this is not the only thing that investors need to take into account before thinking about investing in the company.

But if we just think about market cap, there are three types of market capitalization which investors need to pay heed to small cap, middle cap, and large cap.

When a companys market cap lies between the US $500 million to the US $2 billion, then it would be called as a small cap company.

This range is not set in stone that means you can consider that if the market cap of the company is under the US $2 billion, its a small cap company.

Many investors avoid small-cap company thinking that this sort of company would not generate much return.

However, a small-cap company can turn out to be the biggest advantage for investors who have a small capital to invest in a company. Heres why. Small cap companies are not as famous as large or middle cap companies. Thus, their share price is usually much cheaper than the middle cap and large-cap companies.

And small-cap companies have much greater growth potential. So if you invest in small-cap companies, you would yield better returns even in the economic downturn.

Middle cap companies are those companies which have a market capitalization of US $2 billion to the US $10 billion. These companies have their own advantages.

To investors, these companies are safer to invest in because there is little or no chance of them to go belly up in the future.

So during an economic downturn, when smaller cap companies may go out of business, middle cap companies wontfile for bankruptcy. Moreover, middle cap companies would be having better growth potential than large-cap companies because they have not yet reached the saturation point so as to stop growing further.

And as middle cap companies have more transactions and better hold of companies capital, they usually pay dividends to shareholders which small-cap companies can never do.

Large-cap companiesare big guys and they have a market capitalization of over US $10 billion. They are also called as blue-chip companies.

Large-cap companies are the safest company to invest into because they usually pay dividends to shareholders and if any economic downturn affects the whole economy, they would be able to handle it much better than mid or small cap companies.

But large-cap companies have limited or no growth potential because they have already grown so much that their share price has increased a lot more. So nobody would buy a large number of shares from them at a hefty price.

Another disadvantage of large-cap companies is this investors can rarely get an edge in their investment while investing in large-cap companies because so much information is available to the public.

To get an edge in purchasing shares of large-cap companies, you need to do in-depth analyses of their financial statements and balance sheet to be able to understand whether there the companies are undervalued or not to fetch an opportunity.

We will also illustrate the example of enterprise value so that you can get acomparative analysisof what we are trying to explain.

Here are the details of Company A and Company B

In this case, we have been given both the numbers of outstanding shares and the market price of shares. Lets calculate the market capitalization of Company A and Company B.

Now, if we compare both of these figures (the market caps of Company A and Company B), we would find that the market cap of Company B is more than the market cap of Company A! But lets tweak a few things and calculate Enterprise Value and lets see how it turns out for investors.

Lets calculate the Enterprise Value for both of these companies. We will first compute the market capitalization and then we would ascertain the Enterprise Value of both of these companies.

The market cap in this example would also be the same as in the previous example

Now as we have got the enterprise value of both of these companies, you can understand how different the enterprise value is. If the investor would go to invest into a company by looking at the higher cap, he would be misled by the market cap because then he wouldnt take into account the total debt and the cash. So its always better to go for Enterprise Value instead of only depending on a Market cap to decide for a company.

In this case, the enterprise value of Company A is significantly higher than the enterprise value of Company B. So as an investor, if your goal is to look for the valuation of a company before you decide to invest, the enterprise value would be the computation you should go for.

Now that weve gone through some examples of calculating market cap, lets now calculate market cap of some top companies.

Column 1 contains the number of outstanding shares.

Column 3 is the Market Cap calculation = Shares Outstanding (1) x Price (2)

If you want to calculate market Cap of Facebook, it is simply the outstanding number of shares (2.872 billion) x Price ($123.18) = $353.73 billion

Enterprise Value is a better measure we agree, but you need to calculate market cap for getting enterprise value. To understand this better, heres a list of the market cap of the top 12 biggest companies so that you can get an idea of how it looks on the chart.

This list of the market cap of the Top 12 biggest companies in US billion dollars.

Please note that 5 out of the top 6 companies with the largest market cap are the tech companies (Apple, Google, Microsoft, Amazon, and Facebook).

As mentioned before there is one limitation of the Market cap if we want to be precise and that is this that market capitalization doesnt show the actual figure on the basis of which investors can make a decision. That means the calculation of market cap can be used to find something else, but market cap cant be the only measuring grid for making a concrete decision.

But enterprise value is the right option if you want to base your decision of purchasing shares on the basis of takeover value of the firm. Because here we would add total debt and deductcash and cash equivalentfor finding out the actual takeover value.

In the end, it can be seen that for every large, middle or small-cap company, the market cap is an important concept. But if we take into account the interest of investors, market capitalization is not enough. We need enterprise value to come to any conclusion if we think from the perspective of investors.

This has been a comprehensive guide to What is Market Cap, Meaning, Formula, Market cap calculation, examples, and limitations. Here we also discuss the top 12 biggest companies by Market capitalization, small, middle and large Mcap companies. You may also have a look at these articles below to learn more about valuations

worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu qualification – engg (IIT Delhi), MBA (IIML); This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs, M&As, Private Equity, Startups, Valuations and Entrepreneurship.

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