What You Need to Know About a Stock’s Market Capitalisation

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Earlier in the month, we looked at what “free cash flow” means. Today, let’s take a look at “market capitalisation” and what it means for investors like you.

Market capitalisation, or “market cap” for short, tells us the total market value of a listed company. It is derived by multiplying the current stock price of a company by its total shares outstanding. The market cap of one company can be compared with that of its peers to determine its relative size.

For example, if Company Z is trading at a stock price of $1 and has 200 million shares outstanding, its market capitalisation is $1 multiplied by 200 million shares, giving us $200 million.

Companies can also be ranked according to their market caps under three broad categories: large-cap, mid-cap, and small-cap.

In the US stock market, large-cap companies usually have a market cap of US$10 billion or more, while mid-caps and small caps have market caps of between US$2 billion and US$10 billion, and between US$300 million and US$2 billion, respectively. That said, the boundaries of large-caps, mid-caps, and small-caps are somewhat arbitrary and can differ from country to country.

Market caps, however, should not be used solely to make investment decisions. Our earlier example of Company Z, with a market cap of $200 million, is not necessarily more expensive than a company with a market cap of say, $100 million. The market cap of a company tells us nothing about its value – all it tells us is the size of a company.

To determine if Company Z is worth paying $200 million, one has to look at its valuation. A  simple way to value the company would be to divide its market capitalisation by its annual net profit to derive the price-to-earnings ratio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.