Market capitalization, often referred to as “market cap,” is a financial metric used to determine the total market value of a company’s outstanding shares of stock. It is calculated by multiplying the company’s current stock price by its total number of outstanding shares.
For example, if a company has 1 million shares outstanding and its current share price is $50, its market capitalization would be $50 million.
Categories of Market Capitalization
Large-Cap Companies
- Definition: Companies with a market capitalization of $10 billion or more.
- Example: Apple Inc., Microsoft Corp.
Mid-Cap Companies
- Definition: Companies with a market capitalization between $2 billion and $10 billion.
- Example: Advanced Micro Devices, Inc. (AMD)
Small-Cap Companies
- Definition: Companies with a market capitalization less than $2 billion.
- Example: Mattel, Inc., Conns Inc.
Market Capitalization and Index Eligibility
Market capitalization is a fundamental criterion for a company’s inclusion in major stock indices such as the S&P 500, NASDAQ, and Russell 2000.
Criteria for Index Inclusion
- S&P 500: Generally includes large-cap companies with a market cap of at least $8.2 billion.
- NASDAQ: Includes a variety of technology-based small, mid, and large-cap companies.
- Russell 2000: Comprises 2,000 small-cap companies.
Tax Efficiency and Lower Fees
Tax Efficiency
Market capitalization-weighted index funds, such as ETFs, typically experience lower turnover rates, leading to fewer taxable events. This tax efficiency is more favorable compared to actively managed mutual funds, which may realize capital gains more frequently.
Lower Fees
ETFs with large-cap stocks generally have lower expense ratios as compared to mutual funds.
- Example: SPDR S&P 500 ETF (SPY) has an expense ratio of approximately 0.09%, whereas actively managed funds may have expense ratios over 1%.
Historical Context
Market capitalization has long been regarded as a crucial indicator of a company’s value and stability. The concept became widely standardized with the advent of modern stock exchanges and the growth of index funds in the latter half of the 20th century.
FAQs
Why is Market Capitalization Important?
How Often is Market Capitalization Calculated?
Can Market Capitalization Affect Investment Choices?
Related Terms
- Stock Price: The current price at which a particular share is trading.
- Outstanding Shares: Total shares currently held by all shareholders.
- Exchange-Traded Fund (ETF): An investment fund traded on stock exchanges, much like stocks.
- Mutual Fund: An investment program funded by shareholders that trades in diversified holdings and is professionally managed.
Summary
Market capitalization is a vital metric used to assess a company’s size, determine eligibility for index inclusion, and evaluate investment opportunities. It offers tax efficiency and lower fees in comparison to mutual funds, making it a popular choice among investors for building diversified portfolios. Understanding market capitalization is essential for informed investment decisions and financial analysis.
References
- Investopedia. (2023). Market Capitalization. [online] Available at: https://www.investopedia.com/terms/m/marketcapitalization.asp
- Marketwatch. (2023). What is Market Capitalization? [online] Available at: https://www.marketwatch.com/tools/stockresearch/screener/marketcapitalization
- S&P Dow Jones Indices. (2023). S&P 500 Index. [online] Available at: https://us.spindices.com/indices/equity/sp-500
