A measure of the total value of a company’s outstanding shares according to the stock market, market capitalisation is often referred to simply as ‘market cap’ or ‘capitalised value’. Market capitalisation is used by investors to classify companies into large-cap, mid-cap or small-cap, which is frequently used as an investment criterion, particularly when trying to maintain diversification in a portfolio of assets.
As with most investor ratios, market cap is often used in conjunction with other measures – such as book value – to help analyse a company’s overall value to the shareholder.
How is it calculated?
Calculating market cap is simple and uses the formula:
The price per share of a company and the number of outstanding shares can usually be found out either from newspapers or the internet. The audited accounts will always give the outstanding or issued share capital. A company’s market cap should always be quoted in the currency unit in which the shares are priced.
Company JKL’s shares are quoted at $3.46 each. The company has 3,500,000 shares outstanding. Using the above formula, the company’s market capitalisation is $12,110,000 ($3.46 x 3,500,000) which according to the classifications below would make it a small-cap company.
Classifications are arbitrary but will typically be:
In excess of $10 billion or perhaps $5 billion
$2 billion to $10 billion or $1 billion to $5 billion
Less than $2 billion or less than $1 billion
Free-float market capitalisation
The above method for calculating market capitalisation is referred to as the full market capitalisation. In reality however, not all of the outstanding shares are freely available to be traded – they may be ‘locked’ in a government or strategic holding for example. This information can usually be found out from the company itself or the exchange. There may also be more than one class of share.
Free-float market capitalisation is calculated by multiplying the full market cap by what is known as the free-float factor. This is determined by dividing the number of shares readily available for trading in the market by the total number of shares outstanding, and rounding it up or down to the nearest 0.05 increment.
If we continue with the example of company JKL and if, out of the 3,500,000 shares outstanding, 2,875,000 are readily available to trade, the company’s free-float factor can be calculated as 0.8, calculated as follows:
This means that the company’s free-float market capitalisation is
Market capitalisation will fluctuate on a daily basis as price per share is based on the value assigned to the shares by the stock market. This also means that as a measure, market cap is largely opinion based – depending on a company’s reputation in the market.
This therefore means that market capitalisation might not necessarily be a true measure of a company’s underlying value. That is why the measure is used alongside other measures and ratios when evaluating a company’s financial value.