Why is Market Capitalization an Important Measure of a Company's Value?

What is Market Capitalization?

In the simplest words, it could mean the total value of the company in the market. It is calculated by multiplying the price of one share by the total number of outstanding shares of the company. Outstanding shares are the total number of stocks collectively held by all the shareholders of the company including institutional investors and the restricted stocks held by insiders. You can find the number under the heading "Capital Stock" of a company's balance sheet.

For example, if company A's shares are worth Rs 200 each and it has 1 lakh outstanding shares in circulation, its market capital = 200 x 2 lakh = Rs 2 crore.

Why is it important in measuring company's value?

Market caps basically divide the companies into three categories- large cap, mid cap and small cap. This categorization will help you make a comparison with other companies in the same type of business falling in the same category of valuation. This is not a rigid categorization and can vary but to get a general idea, one can consider the following-

Additionally, it gives you a clearer picture than the value of an individual share that is affected by corporate decisions like bonus, stock split, etc. Two companies with almost same market capital value can have a drastic difference in their share price because of difference in face values.

What does the cap size tell about the stock?

Large cap stocks are generally considered least risky and stable has they have an established businesses set with assets of great value and multiple offices with numerous employees. There is a reasonable history of performance you can look at freely as the information is openly available.

Their activities are also closely watched by the media as the movement in their prices influences the stock market greatly due to their contribution in value terms to the market as a whole.

These companies also have a good capacity to absorb any loss that may occur. But like all things, the future is uncertain and large cap stocks too carry a certain amount of rise (for example the PNB).

Another thing to keep in mind is that large stocks were also small and mid cap stocks at some point, which goes to say that wealth creation potential is higher in small and mid cap companies. They have a high risk and high return combination where your investment can go both ways.

Conclusion

When you are looking at buying the stocks of a company, it is important to look at market capital to get an idea of how much further a stock can grow (if you keeping a long term investment prospective in mind).

Shares of certain companies may look cheaper but that could only be from a split in stocks and you may not stand to gain much. Similarly, a higher value of an individual stock does not mean it is a more valuable company.