To get the gist of market capitalization, it is of absolute necessity that we grasp the meaning of joint stock companies and their capital raising mechanism. In the 19th century when the winds of industrial revolution started blowing over the European continent, small business firms run by families, individuals or partners began to enslave all possible resources to start enormous factories and churn out profits.
Fueled by natural resources and run by skilled labor, these industrial empires pushed all brink of their personal investments to the last possible extent, so much so that the firms no longer had more money to even buy simple raw material. The British royalty and the parliament of Britain came up with a great solution, and an important legislation, (laws or acts) that would help the British to keep their enormous trade, commerce and industries running.
Meaning of Companies
As mentioned above, the business firms could not keep running their business as a result of lack of further capital. In Great Britain, the parliament passed the Joint Stock companies Act, 1844, to solve the problem. It was a new concept, but it made the nation a super power of the modern era.
The concept of joint stock companies is simple, every company would start with the help of a ‘stock’ that would be made up of several ‘shares’. The shares were capital contributions of very small denominations say, for example $1, or $10. Such shares would have a rate of return that would be paid annually that was to be known as ‘dividend’, and apart from that the share could be traded freely.
The liability of a share holder towards the company would be limited to the face value of shares, and the company will be a separate legal institution, with no owner. The share holders are not creditors nor owners of the company. So, what is market capitalization, and how is it related to shares?
Understanding Market Capitalization
The definition that is found in most of the glossaries of financial terms is quite complex. The simpler meaning of the phenomenon can be set forth in one single statement, ‘market capitalization is the market value of all the companies shares taken together’. As mentioned above, the shares are issued at a small denomination and can be traded freely, which is also known as stock trading.
In the modern era, to simplify the procedures of trading of shares, stock exchanges have been established. The stock exchanges are basically stock markets where shares are bought and sold. Now when a particular company issues its shares, it is basically issued at a face value that is as low as $10 or so. Once it goes out into the market, the value of this share rises as per the company’s performance.
The total market value of all such shares is the market capitalization of the company. The value is also known as the market equity of the company. Thus, if a company has 150,000 shares issued to the public, with market value of each one being $70, the total market capitalization would be 70 × 150,000 = 10,500,000.
Market capitalization calculation is however not that easy, as there are several shares that are subject to a lock-in period, or have a different face value or the shares that are issued to creditors. While calculating the actual value of market capitalization, the finance and accounts department add up the realizable, or the current value of all such classes of shares. The overall calculation in real practice in accordance with the International Accounting Standards is rather tough.
In the United States of America, 6 cap levels are used to classify the companies according to their market capitalization. The Mega-cap is the largest one, and companies with capitalization over $100 billion worth are classified into it. The Large-cap contains companies that have more than $10 billion worth of capitalization with Mid-cap ($2 billion-$10 billion), Small-cap ($300 million-$2 billion), Micro-cap ($50 million-$300 million) and Nano-cap (Below $50 million) being the subsequent ones.
I hope the above given information has helped you understand the concept on ‘market capitalization’ to some extent. Before signing off, I would like to mention one last point, that, investing should not be done only by looking at the size of the market cap of the company, as this figure shows only the equity value of the company. But many other factors, mainly the performance potential should be checked before investing. A little bit of research is required, before you take the leap into the stock market.