What is market capitalisation?

What do we mean by market capitalisation?

The whole purpose of a share market is to facilitate the buying and selling of ownership stakes (shares) in publicly-listed companies on a stock exchange, such as the ASX. 

Market capitalisation (commonly abbreviated as ‘market cap’) measures the total dollar value the share market assigns to a listed company at any given time – nothing more, nothing less.

How does market cap work?

As with other markets, the stock market is beholden to the laws of supply and demand. At any given time, a company’s share price reflects the price at which buyers and sellers are willing to trade company shares.

If demand for a company’s shares increases (for example, if it issues a profit upgrade), its stock price will rise. But if the company’s results fall short of expectations, demand for its shares will likely decrease – along with its market price.

The market also assigns a value to the entire company by determining the share price. That’s because each company has only a finite number of shares on issue. 

Suppose Motley Fool Magic Beans (a hypothetical company, for the record) has one million shares outstanding, and the market values them each at $1 a share. In that case, it effectively gives Motley Fool Magic Beans a market capitalisation of $1 million.

By the same logic, if the Motley Fool Magic Beans share price rises to $1.50 a share, market capitalisation also increases to $1.5 million. 

So, a company’s share price fluctuations directly correlate with its market capitalisation at any given time.

How can we calculate a company’s market capitalisation?

The formula for calculating a company’s market cap is straightforward. You multiply the total number of outstanding shares by the current market price of one of its shares. 

Here’s the formula to demonstrate:

Market cap = no. of shares outstanding x current stock price

That will give you an accurate market capitalisation for the company.

Large cap, small cap, micro cap – what do these terms mean?

You might have encountered some size references when investors talk of market caps. Mega cap, large cap, mid cap and small cap are standard terms, and you may have also heard of micro cap or even nano cap shares.

Company size is a helpful way to group investments. This is because the size of a company’s market cap can often tell you much about the company itself – particularly how risky it is to invest in.

For example, large-cap companies are often (but not always) mature, profitable companies with a demonstrated track record of success. On the other hand, small-cap companies are usually just starting out and may have yet to turn a profit. Sometimes, they may even still be in their research and development phase.

This means that large-cap companies tend to be less risky than those with only small market caps. Companies with the lowest market caps – like micro caps and nano caps – should be treated as highly speculative investments.

Many investors use a company’s market cap as a determining factor when deciding whether or not to buy its shares. For example, you may purchase shares only in companies with larger market caps if you are more risk-averse. 

Company size also helps define the businesses that an index, analyst, or fund manager might cover. For example, a micro-cap analyst is only interested in young companies with small market capitalisations. 

There are no universal rules dictating what makes a large or small cap share, but here is a common framework:

Mega cap

A mega-cap share typically has a market capitalisation of $200 billion or higher. There is only one share on the ASX with a market cap this big. That’s the diversified miner BHP Group Ltd (ASX: BHP), which has a market capitalisation of about $240 billion at the time of writing. The ‘big four’ bank Commonwealth Bank of Australia (ASX: CBA) is not far off with a market cap of about $185 billion. 

There are many mega caps on global exchanges. These include tech juggernaut Apple Inc. (NASDAQ: AAPL), global oil giant Saudi Arabian Oil Co (TADAWUL: 2222), and computer software pioneer Microsoft Corp (NASDAQ: MSFT), all with market caps of around an eye-watering US$2 trillion. 

Large cap

Large-cap stocks have a market capitalisation of $10 billion or higher. Most of the ASX 50 blue-chip companies come under this label. Leading biotech company CSL Limited (ASX: CSL), insurer QBE Insurance Group Ltd (ASX: QBE), and supermarket chain Woolworths Group Ltd (ASX: WOW) are all large-cap companies. 

Mid cap 

A mid-cap company usually has a market capitalisation of between $2 billion and $10 billion. These shares aren’t traditionally labelled ‘blue chips’ but can still be found in the ASX 100. Popular telco TPG Telecom Ltd (ASX: TPG), digital jobs listing company Seek Ltd (ASX: SEK), and diversified media company Seven Group Holdings Ltd (ASX: SVW) are all mid-cap companies.

Small cap

These are companies with a market cap ranging from a few hundred million dollars to $2 billion. These companies won’t typically be found in the ASX 100 but might still appear in the S&P/ASX 200 Index (ASX: XJO). The S&P/ASX Small Ordinaries Index (ASX: XSO) aims to cover small-cap shares by excluding the ASX 100 from its listings. Some of the better-known ASX small-cap companies include health supplements company Blackmores Ltd (ASX: BKL), medical device company Polynovo Ltd (ASX: PNV) and casino operator SKYCITY Entertainment Group Limited (ASX: SKC), all with market caps of about $1.7 billion.

Micro cap

Micro-cap companies are often called ‘penny stocks’ and have market capitalisations typically ranging from $50 million to $300 million. Many ASX investors regard micro-cap stocks as a ‘high-risk, high reward’ arena and shy away from investing in this space. Micro-cap stocks include potential growth shares like accounting and financial services company Kelly Partners Group Holdings Ltd (ASX: KPG), breast cancer screening firm Volpara Health Technologies Ltd (ASX: VHT), and transport and freight company Silk Logistics Holdings Ltd (ASX: SLH).

Nano cap

Any listed share with a market capitalisation of $50 million or less can be labelled a nano cap. These are highly speculative investments, as there is usually very little research or data available to retail ASX investors. Nano-cap stocks may include very junior companies, mineral exploration companies looking to strike it rich, or tech and biotech start-ups. Nano-cap shares are extremely risky, and you should ensure they align with your investing strategy before deciding to invest in them.

What are the largest companies listed on the ASX?

The three largest companies on the ASX represent three of Australia’s strongest economic sectors – mining, banking, and healthcare.

BHP Group 

Mining giant BHP is one of the largest mining companies in the world. It is the world’s largest coal producer and generates significant amounts of nickel, copper, and iron ore. At this point, BHP is so extensive and well-diversified that investing in the company’s shares is almost like buying a mining exchange-traded fund (ETF). 

The company has a long and successful history. It was formed out of the merger of Broken Hill Proprietary (BHP) and Billiton, two companies originally founded back in the 1800s. 

Commonwealth Bank

CBA is easily the largest of Australia’s big four banks. It is also one of the country’s most recognisable and well-respected brands. This makes it a popular choice among retail investors, and it pays a consistent and reliable dividend.

CBA also has a long history. It was founded in 1911 by the Federal Government’s Commonwealth Bank Act, and held many central bank powers until the Reserve Bank of Australia was formed in 1960. The privatisation of CBA began in 1991 and was eventually completed in 1996.

CSL

CSL started life in 1916 as Commonwealth Serum Laboratories, a government enterprise originally intended to help safeguard the health of Australians during World War I. Over the years, the company has supplied the nation with modern treatments and medicines, including penicillin, insulin, and vaccines against polio and influenza.

CSL has grown into a well-diversified biotech company, split into four key businesses. CSL Behring specialises in rare and serious diseases, CSL Seqirus develops vaccines for influenza, CSL Plasma is a global leader in plasma collection, and CSL Vifor specialises in nephrology and iron deficiency.

What’s the difference between market capitalisation and enterprise value?

Some critics argue that a company’s market cap doesn’t provide a complete picture of its true value. This is because the market cap only considers the value of a company’s equity (or outstanding shares).

An alternative to market cap is enterprise value. Many consider it a more comprehensive way of valuing a company because it also takes into account its cash reserves and debt.

We can calculate enterprise value using the following formula:

Enterprise value = market cap + total debt – cash and cash equivalents

Enterprise value is the preferred way to value companies targeted for a takeover or a buyout. This is because whoever acquires the company also takes on the debt and gains control of its cash reserves. Therefore, the acquirer must factor these items into its valuation before entering into a sale.

Does market capitalisation matter?

When an investor attempts to value a company using a price-to-earnings (P/E) ratio or similar metric, they are measuring the company’s market capitalisation against its profitability or cash generation. 

In this way, market capitalisation is a valuable tool in investing and can greatly assist in determining the correct share price to pay for a company. However, using a variety of financial metrics will help you make the best and most informed investment decisions.