What Is Market Cap & How Does It Work?
Market cap offers a quick and effective measure of a security's value. Learn how it's calculated, categorised and influenced in our trader's guide.
Knowing a security's market cap can help you to assess its risk-and-reward potential and diversify your portfolio. Build your knowledge as we walk you through all you need to know:
What is market cap?
Market cap is short for market capitalisation. It's a simple but important figure, estimating how much a company is worth based on the total market value of its outstanding shares of stock. Market cap is commonly used as an analysis tool by investors and traders.
Free-float market cap
While standard market cap calculates the total value of all company shares, free-float or float-adjusted market cap focuses on those available to the general public. This method excludes 'locked-in' shares held privately by company executives, governments and other parties.
Free-float market cap is seen to provide a clearer picture of how the market values stock. As such, it's adopted by many of the world's leading stock indices such as the S&P 500 , as well as investment funds.
Coin market caps
We've introduced what market cap is in relation to stocks but it can apply to other asset classes such as cryptocurrency, too. Coin or crypto market cap measures the total value of all of a cryptocurrency's coins currently in circulation.
How to calculate market cap
The formula for calculating market cap is a simple one:
Market cap = Total number of outstanding shares x Current share price
For example, if a company issues one billion shares of stock and these shares are priced at $5 each, the company's market cap is $5 billion. Alternatively, the company could issue half the number of shares at the double the price and achieve the same market cap.
This broad valuation is first determined through an initial public offering (IPO). In short, a company wishing to go public will use an investment bank to judge its value and advise on how many shares it should offer and at what price, among other considerations.
Once this company goes public, share price is set by supply and demand in the market, with market cap providing a real-time value estimate of the company. High demand will increase share price and vice versa.
What market cap tells you
Market cap is a quick, easy estimate of company value compared to others, based on market sentiment. It's primarily used by investors and traders to assess risk, helping you to choose stocks and diversify your portfolio strategically.
It can infer a company's stage of development, for example. Large-cap stocks usually belong to well-established companies, while smaller-cap stocks can be younger and have greater opportunity for growth.
This may also inform their stability; large-cap stocks tend to be more resistant to market fluctuations, while smaller-cap stocks are more volatile. Both hold different appeals for different investors and traders based on factors such as risk tolerance, financial goals and timescales.
Limitations of market cap
Market cap does have limitations, however. While it tells you perceived company value based on stock price, it can't tell you the actual value of a company and all its debts, assets and cash. This is where enterprise value comes in, which can be more helpful if you're considering buying a company outright.
This is in part because shares are often over- or undervalued by investors, usually tied to how they expect companies to perform over time. If these expectations aren't realised, share price and market cap should adjust accordingly.
Categories of market cap
Many stock indices, investment funds and financial analysts group securities by market cap. While there are no universally agreed boundaries, you can read general summaries of high-, mid- and small-market cap assets below.
What is a high market cap?
Large-market-cap companies usually have a market cap of $10 billion or more. So-called mega-cap companies, meanwhile, can have market caps of over $200 billion.
Both categories usually represent companies that have been major players in well-established industries for several years or decades. They're likely to have a widely known reputation for producing quality goods and services, as well as delivering consistent dividend payments and steady growth to shareholders.
High-market cap companies tend to resist market downturns better than others, often thanks to large cash reserves. As a result, they're often safer, more conservative investments, combining lower risk with lower growth potential.
What is a mid market cap?
Moving down one rung, mid-cap companies typically have a market cap between $2 billion and $10 billion.
These companies are usually less mature than large-cap companies but operate in industries experiencing - or predicted to experience - fast growth. They may well be in the process of expanding themselves. This categorisation gives them greater growth potential but less certainty and stability of performance.
What is a low market cap?
At the bottom sit low-market cap companies. Small-market-cap companies generally have market caps between $300 million and $2 billion, while micro-cap companies have values from $50 million to $300 million.
Their nature means that low-market-cap companies are considered the riskiest investments. They're usually younger and/or operating in new or niche industries, with fewer resources upon which to fall back in economic downturns.
Resultantly, small-cap shares are often more volatile and less liquid than mid- and large-market-cap companies. At the same time, they also have the highest upside due to having the most room to grow.
What is diluted market cap?
Market caps can change if more shares are issued, as new offerings effectively 'dilute' the value of existing shares in the market by increasing supply.
If aiming to predict what a new market cap will be before this issuing, you multiply the current share price by the new predicted total number of shares. This formula gives you what's called the diluted market cap.
Diluted market cap is especially relevant in crypto markets, where new coins can be issued frequently.
What can impact a company's market cap?
As well as changes in the number of shares issued as highlighted above, significant swings in share price impact market cap. Such movements can be due to a wide range of factors influencing demand including earnings reports, competitor activity and economic health. Read more about what affects stock prices.
What is a good market cap?
Most small- and mid-market-cap companies will aspire to become large market caps. But in the context of trading, good market cap is relative to your trading goals and portfolio. Large-cap companies are safer in the long term, for example, while small-cap companies offer better rewards if they grow.
Like trading across asset classes, trading across a range of market caps can be an effective way to balance this risk-and-reward dynamic. You may include a bigger or smaller allocation of certain-cap securities in line with your trading strategy and preferences. Read more about diversifying your trading portfolio.
With Tradu you can trade crypto via CFDs.