Market capitalization, or market cap for short, is a relatively simple way to see how the market and general public value a company. If you’re trying to assess the risk in buying a company’s stock, or you’re looking for companies with more growth potential, market cap could help you make a more informed decision.
How do you calculate market cap, and how can it help you make better investing decisions?
What is market cap?
Market cap is the total value of a company’s stocks. You calculate it by taking the number of outstanding shares and multiplying them by the current price per share. The resulting number is theoretically how much you would need in order to buy every share in a company’s stock. For example, if Company Y had 30 million shares, with each share worth $20, that company’s market cap would be $60 million.
Market cap can help you see how big or small a company is, which isn’t always reflected in its share price. For example, alongside Company Y, let’s say we have another company, Company Z.
- Share price: $20
- Outstanding shares: 30 million
- Share price: $100
- Outstanding shares: 5 million
At first glance, you may think Company Z is bigger or more valuable than Company Y, since its share price is valued higher. But when you calculate the companies’ market caps, you can see Company Y’s stock has a higher overall value. At $20 a share price, Company Y has a $60 million market cap ($20 x 30 million), while Company Z has a $50 million market cap ($100 x 5 million).
What is a free-float market cap?
Sometimes, you’ll see “free-float market cap” instead of market cap. When investors or analysts measure a company by the free-floated method, they exclude shares that are locked-in by executives, private parties, or governments. These shares are not for public sale, and since they’re not actively traded on the market, many believe excluding them will give you a more accurate picture of a company’s size.
On the other hand, when you see “floated,” that means the market cap includes all shares, whether publicly traded or privately held. The floated market cap will usually be significantly higher than the free-floated one, since it contains more shares.
What are the different market cap sizes?
You’ll often see companies classified according to their market cap sizes. Based on their CAD, these classifications typically fall into three big groups: large-caps, mid-caps, and small-caps.
What are large-caps?
Large- or big- cap companies typically have a market cap of $10 billion or more. As their name suggests, large-caps are big, long-established companies that have outlived their rivals and created brands that are household names. In Canada, large-cap companies include:
- Enbridge Inc. (TSX:ENB)
- Royal Bank of Canada (TSX:RY)
- Shopify (TSX:SHOP)
- Suncor (TSX:SU)
- Thomson Reuters Corporation (TSX: TRI)
Since large-caps have longer tract records, they’re usually safer investments than mid- or small-cap companies. Though large-caps don’t have immense growth opportunities, they can help investors earn steady returns over time (usually with dividends, too). And when the market hits a dip, large caps often retain most of their value.
What are mid-caps?
Mid-cap companies are worth between $2 and $10 billion. These companies are often appealing to investors because of their expected growth and potential increase in profit.
Because they’re smaller than large-caps, mid-caps might be a little more risky, but they’re certainly not as risky as small startups and younger brands. Investors often add mid-cap companies to their portfolios because they have growth potential, while also offering some stability. In Canada, popular mid-cap companies include:
- Air Canada (TSX:AC)
- Blackberry (TSX:BB)
- CargoJet (TSX:CJT)
- Kinaxis (TSX:KXS)
- Northland Power (TSX: NPI)
Because they occupy the middle ground of market caps, mid-caps are an extremely diverse bunch. Some mid-caps could be growing companies that are well on their way to becoming large-caps. Others once were large-caps, but they’ve fallen back into the mid-cap range, usually because of internal problems or market disruptions. Still other mid-caps may be the leading companies in their niche, but their niche is so small, it’s hard for them to grow.
For that reason, it’s always a good idea to look into the history of mid-cap companies to see if they’re a true growth stock or a stagnating company.
What are small-caps?
Small-caps are often start-ups or young companies with a value of $300 million to $2 billion. Because of their potential to grow bigger, small-caps offer the possibility of immense returns, making them a favorite of growth stock investors. Some common small-cap companies include:
- Absolute Software (TSX:ABT)
- goeasy (TSX:GSY)
- GoodFood Market (TSX:FOOD)
- Hexo Corp. (TSX:HEXO)
- Pizza Pizza Royalty (TSX:PZA)
- Tecsys (TSX:TCS)
Of the three market caps, small-caps are the riskiest investments. They may offer growth opportunities, but their size and limited resources means they can easily take a turn for the worse in a market downturn. If you choose the right companies you could see significant returns, but you’ll likely experience a few short-term losses, especially if the company is emerging in a new or untried market.
What about micro- and mega- caps?
Finally, some companies are so big (or, conversely, so small) they fall into another classification, mega- or micro- caps.
Mega-caps, or ultra-caps, are companies that have reached $50 billion or more. These companies are leaders in their industries, and their stability makes them extremely safe investments, though also the least likely to bring in extraordinary gains in the short-term.
Micro-cap companies have values that are less than $300 million (if their value is less than $50 million, you’ll sometimes see these companies called “nano-caps.”). These companies are often very young and volatile. They could become leaders in their industries, helping you seal immense gains, or they could disappear overnight.
What makes market caps change?
Two factors influence market caps: the number of available shares and the movement of share prices.
If a company issues more shares, either to raise more money or answer demand, you might see a positive change in the company’s market cap. Likewise, when a company’s stock shares go up, the market cap often goes up, too. The reverse of these is true, as well: a decrease in available shares (for example, if a company buys back shares) or a share price decrease will negatively impact that company’s market cap.
Because the market changes every day, you’ll likely see a company’s market cap change slightly, too. Small changes shouldn’t be alarming. If a company’s market cap changes by double digits, or if it changes classifications, you might want to look into what’s going on.
Why is market cap important?
In general, market caps help you see how much a business has developed. As you’re building your investment portfolio, market caps help you decide which companies you should include and which companies you might want to think more about. Here are some ways market caps can help you make informed investing decisions.
1. Market cap helps you identify growth potential
Market cap can help you see which companies are in the process of growing and which aren’t. In general, small-cap and mid-cap companies have far more growth potential than large-caps, though less stability. For long-term investors who can stomach market volatility, identifying good small- or mid-cap companies could earn you a significant amount of gains over the long-haul.
2. Market cap helps you assess risk
If you’re a more conservative investor, market cap can help you pick out big, stable companies that are less volatile than exciting-but-dangerous small caps. Large-caps may not offer you aggressive growth opportunities, but if it’s security you’re looking for, large- or mega- caps could bring greater stability to your portfolio.
3. Market cap can help you diversify
If you want both growth potential and security, market cap could help you pick out a well balanced portion of both. By identifying great small- or mid-cap companies (or even micro-caps), you could potentially take advantage of a young company’s immense growth. On the other hand, if a market downturn or recession bankrupts your small-cap investments, large-caps could potentially protect you from losing more.
How does market cap compare to enterprise value?
Market cap helps you calculate how much a company is worth based on its stock shares. But it’s not the only valuation, nor the most accurate, of a company’s market value.
Some investors like to use “enterprise value” instead of market caps. Basically, enterprise value tells you how much a company is worth if you take into account its debts, assets, and cash flow. It’s more difficult to calculate, but it often gives you a more accurate picture of a company’s worth.
In sum, market cap tells you how much you would need to buy every share of a company’s stock. Enterprise value tells you how much you’d need to acquire the company outright. Many experienced investors use enterprise value, along with other market value evaluators (such as price-to-earning and price-to-sale ratios), to determine if a company’s stocks are under- or over-valued.
The Foolish takeaway on market cap
Looking at a company’s market cap can be a great starting place to determine where a company is in its growth. Because of this, market cap can help you build a portfolio that helps you accomplish your investing goals, while also staying within your risk tolerance. If your goal is to see as much growth as possible, you’ll probably want to add great small- and mid-cap stocks. On the other hand, if you’d like more stability, large-cap stocks could help you hedge market risks.
Limited Time Only: Get 5 of Our Top Growth Stocks for FREE.
We are giving away a FREE copy of our “5 Small-Cap Canadian Growth Stocks Under $5” report. These are 5 Canadian stocks that we think are screaming buys today.