Finance

Why is Market Capitalisation an Important Measure of a Company’s Value?

Investing in the stock market is one of the top investments options that has proved to yield good results in the long term. When an investor decides his/her investment strategy, one of the important factors they take into consideration is the company’s market capitalisation. Let’s dive deep and understand what is market capitalisation and what an important role it plays in respect to your stock investment decisions.

What is Market Capitalisation?

Market capitalisation is the total value of the company which is publicly traded. In other words, it measures a company’s worth in the open market. Market capitalisation is also referred to as market cap. The market capitalisation acts as a determining factor at the time of evaluating a stock in terms of value in comparison to its peers. An investor can ascertain the returns and the risk in the share by taking a look at the market capitalisation of that particular share. Moreover, they can select the stock that can meet their risk and diversification criteria. It is calculated by multiplying the total number of shares outstanding and the current market price. For example, if a company has 1 lakh outstanding shares and the current market price of 1 share is Rs.200, the market capitalisation of the company will be 1 lakh x Rs.200 = 2 crore. The market capitalisation of a company is not constant and changes rapidly on a single day.

At present, the most valuable company in the world is Apple with a market capitalisation of over $945 billion, followed by Alphabet and Microsoft at second and third spot. According to a latest report from PwC titled ‘Global Top 100’, the total market cap of the top 100 global companies reached $20 trillion.

Importance of Market Capitalisation

Market capitalisation is one of the easiest and quickest way to value a company. The price of a single share of the company is not enough to decide its overall value as it does not give you an idea of the profitability and size of the company. This is where market capitalisation comes in handy. It is a common misconception that if a company’s share price is higher, it is also higher in terms of valuation. Therefore, one should compare the market capitalisation of two companies instead of comparing their stock prices to understand their real worth. Two companies with almost the same market capitalisation can have a huge difference in their share prices because of the difference in their face values.

Classification of companies in stock market

Stocks are classified based on their market capitalisation. The market categorises stocks into 3 types viz; small-cap, mid-cap and large-cap. Usually, there are no hard and fast rules about the classification of the stocks. As the name suggests, large-cap stocks are stocks of the companies that are well established and have a sound market position. The stocks with a market cap of Rs.10,000 crore or more are classified as large-cap stocks. For example companies like Reliance Industries, HDFC Bank, Sun Pharmaceuticals, etc., are large-cap stocks. Buying stocks of these companies is considered to be safe and has a relatively less risk attached to it. Meanwhile, in order to fall in the mid-cap stock category, the company stocks should have a market cap between Rs.2 crore and Rs.10 crore. Mid-cap companies have smaller revenues and client base as compared to the companies that fall in the large-cap. For example, Kajaria Ceramics, Castrol India, etc., are some of the companies that fall in the mid-cap range. Mid-cap stocks have great potential attached to them and have a higher possibility of yielding decent returns in the long run. Finally, the companies whose market capitalisation is less than Rs.2 crore are categorised as small-cap stocks. These are the companies that are in their development stage. Companies like Indiabulls Ventures, HEG Ltd., and others fall in the small-cap section.

Final Thoughts

There are several factors that affect the stock market that results in fluctuations of the share prices. Inflation, elections, natural disasters, change in the interest rates, gold and oil prices, social unrest are some of the factors that are responsible for fluctuations in the stock price. It must be noted that in addition to the market capitalisation, investors should also look at other factors that determine the valuation of the company. The company’s P/E (price to earnings) ratio, D/E (debt to equity) ratio, predictability of earnings, balance sheet, cash flow, pricing power, and management of the companies are some of the factors that should be taken into consideration.

One of the key things to remember while investing in stocks is to focus on having a diversified portfolio. Never put large quantities of money in one stock. Instead, spread your investments across stocks from small-cap, midcap, and large-cap in order to gain sizeable returns. Always have defined financial goals before you start investing in stocks and also understand your risk tolerance. If you are first-time investor, there is no harm in taking help from a financial expert as it will help you take better decisions in terms of investments. Finally, investing in stocks is a great long-term investment but it comes with a good amount of risk and uncertainty. Hence, it is strongly advised to do your own research before investing your hard-earned money in stocks. You can refer to websites like Bankbazaar.com to understand in-depth analysis of different company stocks.

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Aadhyakumar

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