Market Cap: What is it and how does it work?

If you’ve been involved in stocks for any amount of time, it’s likely that you’ve come across market caps. In fact, the market caps of some of the biggest companies on Wall Street are over 1 Trillion, with the largest market cap at over 2 Trillion (for contrast, Australia’s GDP is 1.553 trillion USD). 

So, that’s a lot of big numbers. But what are market caps and do they reflect the actual valuation of a company?

How is a market cap calculated?

Market capitalisation is the aggregate value of a company’s outstanding shares of stock. It is computed by multiplying the company’s share price by its total number of outstanding shares. The formula is actually pretty simple:

Market cap = current share price × outstanding shares

Basically, this is a way of seeing how much the market is valuing a company by both retail and institutional investors. However, this is a general way of seeing how valuable a company is. 

If a stock has a large market cap, this does not necessarily mean that the company is healthy (cash flow or debt), just that it likely dominates in its industry. Likewise, a smaller market cap doesn’t necessarily mean a company is in dire straits. Instead, small market caps can often mean a new player to an existing or newly made industry. 

Market cap can be a useful metric for determining how the rest of the market is valuing said company. Valuing a stock by market cap shouldn’t be the only thing you consider though. Instead, research and consider other aspects of a business like cash flow, debt, market share and other industry-appropriate considerations (e.g. does this tech company have the best tech?) can help you determine whether you should invest in a company's stock.

Are cryptocurrency market caps different?

While the core concept remains similar, the highly volatile nature of cryptocurrencies lends a different character to crypto market caps. Traditional market caps are tied to companies with physical assets and revenues, while crypto market caps revolve around digital assets whose values are much more speculative.

The formula is similar to a traditional market cap found in share trading, just adapted for crypto:

Crypto Market Cap = current price per coin × total circulating supply

How are large, mid, and small market cap sizes determined?

You’ll usually find investors categorise companies by market cap, which consists of small-cap, mid-cap, and large-cap. Companies will be classed as one of these three based on a certain market cap such as:

• Small-Cap Companies: Tend to have a market cap of less than $2 billion. They are considered to be more volatile and risky, yet they also have a higher growth potential.
• Mid-Cap Companies: These often sit in the middle with a market cap between $2 billion and $10 billion. This kind of stock usually offers a balance of growth potential and stability.
• Large-Cap Companies: Boast a market cap of more than $10 billion and are often well-established firms with a stable earnings record. The larger the market cap, the more unlikely they are to grow substantially (A growth from 1 to 10 billion is more likely than 1 trillion to 10 trillion).

Categorising by market cap can help you gauge the risk and return profile of a company and where they are on their growth curve.

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