When discussing stocks, those who aren’t too familiar with the world of finance might be curious about the market capitalization definition. Contrary to popular belief, it’s not just capitalizing the word “Market”. It’s actually a measure used to figure out the value of a company at a given moment in time. To further clarify the concept, let’s delve into the mathematical definition of market capitalization, and see what it actually means.
Calculating Market Capitalization
For publicly traded companies, market capitalization (or market cap) is pretty easy to figure out. The first number used is the total number of shares of stock “outstanding” (issued by the company). For example, Company X might issue 1,000 shares of stock to help raise funds for their operations. The second number is the price of each individual share. This price changes constantly, and is determined by investors who buy and sell the shares on the market. So, assume Company X’s shares are currently priced at $10 apiece.
To determine market capitalization, all you’ve got to do is multiply the first number by the second number. In Company X’s case, its market cap would be $10,000. Note that this example is laughably low; the neighborhood kids’ lemonade stand would probably have a higher market cap. But Company X-as poor as it is-still serves as a useful example.
What Market Capitalization Means
Being able to multiply one number by another is cool and all, but knowing a company’s market cap is pretty useless unless you also know what it means. Financially, the number represents what investors think the company is worth. In short, it is the company’s so called “market value” at any given time.
It’s important to know that market value and book value-which is what you’d see under “total assets” in the company’s balance sheet-aren’t the same thing. While market cap shows what investors believe the company is worth, it does not necessarily equal the actual value of all the company’s assets. More complicated stuff like future earnings, sector growth, and company growth get factored in by the suits trying to make a buck in the stock market.
The result of this disparity can actually lead to some pretty interesting things. In the dot-com boom of the early 21st Century, for instance, investors looked at new companies with the rosiest of rose colored glasses on. Even though these companies had few real assets and even fewer dollars in revenues, investors bet big on their future earnings, pushing their market capitalization numbers to gargantuan levels. As you may already know, this led to what is now known as a “big freaking bubble”, which subsequently burst hard. So, even though market capitalization is simple enough to determine mathematically, its implications in the market itself are often mysterious.
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