Market cap explained: what it is and why it matters

What’s on this page?

1. What is market capitalisation?

2. How to calculate market cap

3. Factors that affect market cap

4. Different types of market caps

5. Why market cap matters to investors

6. Market cap vs other valuation metrics

7. Investment strategies based on market cap

What is market capitalisation?

Market capitalisation (market cap for short) is the total value of a listed company's shares. It’s often used to classify companies by size, ie whether it’s large, medium or smaller. This makes it possible to track changes in a company’s value over time and compare it to similar companies based on their stock market value.

The market cap category of stocks that you buy and hold reflects how much risk you’re willing to take. For example, there’s more risk involved in holding smaller cap stocks as they’re more sensitive to economic downturns and their price movements are often more volatile.

Market cap is also used as a metric to determine whether a stock qualifies for inclusion in capitalisation-weighted indices. Examples of such indices are the S&P 500 and the FTSE 100.

It's important to note that market cap only represents the equity value of a company. It doesn't account for other factors, like debt, which would be considered in enterprise value calculations.

How to calculate market cap

A company’s market capitalisation is calculated by multiplying its current share price by its total number of available shares. It represents the total value of the stock’s outstanding shares.

If Company ABC has 1,000,000 shares outstanding and each share is worth £50, for example, its market cap is £50 million (1,000,000 × £50).

As a stock’s price changes, so will its market cap, making the latter a real-time estimate of company value. So, if Company ABC’s share price moved up to £55, its market cap would be £55 million.

Factors that affect market cap

Below are some of the key factors that can affect market cap.

• Stock price changes

• Corporate actions

• External factors

Stock price changes

When a stock’s price changes, the market cap changes as well since it’s used to calculate market cap. Stock price performance is driven by market sentiment and investor confidence, which determine demand for buying and holding a stock.

Here are some of the main factors that influence market sentiment and investor confidence:

• Company performance: factors such as earnings and revenue growth, profit margins, debt levels and return on investment (ROI)

• Management credibility: eg strategic vision and execution, leadership track record and crisis management

• Future growth expectations: revenue growth drivers, market share dynamics, factors that could impede growth and more

• Market position and brand strength: including competitive advantages, strategic flexibility and ability to maintain market share

• Innovation potential and industry trends: eg research and development capabilities, opportunities for expansion and ability to lead or adapt to industry changes

• News and announcements that affect a company: management team changes, financial performance updates, regulatory changes and more

• Economic conditions: aspects such as changes in consumer spending, interest rates and international trade dynamics

Corporate actions

Corporate actions can affect a company’s market cap in different ways – either by changing the share price, the total number of shares, or both. For example, in a stock split the share price drops, while it increases in a reverse stock split. In both cases, you’d still own shares to the same amount as before – you’d just have more shares as a result of the former, and fewer shares following the latter.

Learn more about stock splits and reverse stock splits

In cases of dividend payments, for example, the share price typically drops by the amount paid to shareholders on the ex-dividend date. Other corporate actions that could affect share price include mergers and acquisitions (M&A), share buybacks and rights issues.

External factors

There are factors outside of a company that can move its share price, resulting in its market cap changing as well. Below are some of the areas where certain external factors can affect a stock’s price action through market sentiment.

• Industry-specific factors: costs of raw materials, consumer trends, regulatory changes, technological disruption and competitive landscape

• Monetary policy and interest rates: quantitative easing or tightening, for example, affects borrowing costs, which can impact companies’ funding capacity and their target markets’ spending power

• Economic conditions: recessions, employment levels, changes in gross domestic product (GDP) and inflation

• Global events: pandemics like Covid-19, and geopolitical issues and dynamics (eg social unrest, wars and climate policies)

Different types of market caps

There are different market cap types. These are classified based on company size – more specifically, how much a stock’s shares are worth in total.

The different types of market cap stocks are:

• Mega-cap stocks

• Large-cap stocks

• Mid-cap stocks

• Small-cap stocks

• Micro-cap stocks

• Nano-cap stocks

Not only do these types help in tracking a company’s worth over time, they can be used to compare companies based on their value in the stock market. You can also use market-cap classifications to choose your strategies based on your preferred risk level and other factors relating to the categories.*

Mega-cap stocks and large-cap stocks

Classification and examples

Mega cap

• $200 billion and above

• Examples: Apple, Microsoft and Saudi Aramco

Large cap

• Between $10 billion and $200 billion

• Examples: Coca-Cola, Nike and Shell

Characteristics and typical sentiments*

• Industry leaders with global presence

• Usually have long operating histories

• Often pay regular dividends

• Generally more stable and less volatile

• Typically used for wealth preservation

• Usually have strong balance sheets and cash flows

• Often used as long-term core holdings by conservative investors and retirees

Mid-cap stocks

Classification and examples

• $2 billion to $10 billion

• Examples: Mercury Systems, Crocs, Mattel and Harley-Davidson

Characteristics and typical sentiments*

• Companies that have passed the initial growth stages

• Balance of stability and growth potential

• Typically expanding nationally or internationally into new products or markets

• Often targets for acquisition by larger companies

• Generally used by balanced investors (with a moderate risk tolerance level) seeking growth

Small-cap stocks, micro-cap stocks and nano-cap stocks

Classification and examples

Small cap

• $300 million to $2 billion

• Examples: Anterix, Lifezone Metals and AMTD Digital

Micro cap

• $50 million to $300 million

• Examples: Myomo, VOXX and Puma Biotechnology

Nano cap

• Below $50 million

• Smallest public companies

• Often the most volatile and least liquid

• Examples: Sphere 3D, Sow Good and Draganfly

Characteristics and typical sentiments*

• Higher growth potential

• Often younger companies still in growth phase

• May have limited trading volume, but price movements are often more volatile

• Higher risk, but higher returns potential

• Often focused on specific niches or regional markets

• Less analyst coverage

• More sensitive to economic downturns

• Often used by growth-oriented investors who are comfortable with risk

Examples provided are based on the companies’ market capitalisations as at Dec 2024.

Why market cap matters to investors

• Size and stability indicator

• Risk assessment

• Investment decisions

• Company comparisons

Size and stability indicator

Market cap serves as an indication of how big and established a company is. A larger market cap usually means that the company is more stable; a smaller market caps suggests that there’s higher risk, but potential for growth is also higher.

See how company sizes are classified by market cap

Risk assessment

Market cap can also indicate the level of risk that’s involved in investing in a certain stock. Stocks with larger market caps generally have less volatile price action and higher liquidity, while the price of smaller-cap stocks often have more volatility and lower liquidity.

Investment decisions

When deciding where to buy and hold, there are various factors that are typically considered – market cap is one of them. This is because companies of different sizes tend to perform differently in various economic conditions. In fact, there are even investment strategies that are based on market cap, including focusing on exchange-traded funds (ETFs) that track specific market cap ranges.

Company comparisons

Market cap is a way of comparing companies, whether they’re in the same industry or not. This adds a layer that you can get useful insights from when weighing companies against each other in search for opportunities. Other factors you could consider include share price, profitability and competitive advantage.

Market cap vs other valuation metrics

In addition to market cap, there are several ways for you to gauge the value of a stock. Each metric's usefulness depends on aspects such as industry context, company growth stage and business model and investment goals.

Market cap vs price-to-earnings (P/E) ratio

• Market cap shows total value based on share price and number of shares; P/E ratio shows value relative to earnings

• P/E ratio helps compare potentially over- and undervalued stocks within same industry – market cap alone doesn't tell you this

Market cap vs enterprise value (EV)

• EV is determined by incorporating market cap: the calculation for EV is = market cap + debt - cash

• EV gives a more comprehensive figure of a company's total value

• Useful in for comparing companies with different debt levels

• Important for acquisition analysis

Market cap vs book value

• Market cap shows what investors are willing to pay in the stock market

• Book value shows company's accounting value (assets minus liabilities)

• Book value amounts to the worth of the company if it were to be liquidated, whereas market cap gives the maximum price at which the stock can be bought

• Certain companies have high market caps but low book values due to intangible assets, eg tech companies

Other valuation metrics include price-to-sales (P/S) ratio, revenue growth, free cash flow and price-to-book (P/B) ratio.

Investment strategies based on market cap

• Small-cap strategy

• Large-cap value strategy

• Market cap rotation

• Index-based approach

Small-cap strategy

The focus of the small-cap strategy is to buy and hold companies with a market cap that’s less than $2 billion. The aim is to capitalise on the potential growth opportunities that exist in this range.

More extensive research would be needed for this strategy as there's less analyst coverage. A certain level of comfort with risk is useful when employing the small-cap strategy as liquidity and trading volumes tend to be lower, while volatility is often high.

Large-cap value strategy

The large-cap value strategy targets stable, established companies and focuses on dividend income and steady growth. In employing this strategy, you’d generally look for market leaders with strong fundamentals.

This strategy aims to preserve and build wealth. But selling at a higher price in the long run isn’t the only way of making a profit with this strategy, as large-cap stocks typically provide a passive income through regular dividend payments.

Market cap rotation

The market cap rotation strategy requires active management. This strategy can help manage your overall portfolio risk through diversification, as different caps often perform well at different times.

You can use the market cap rotation strategy to diversify by switching between cap sizes based on economic cycle. For example, you can move to small caps early in economic recovery and then shift to large caps during uncertainty. To do this, you’d watch economic indicators for timing purposes, while monitoring performance closely.

Index-based approach

Through employing the index-based approach, you’d invest in ETFs that track specific market cap ranges, eg IWM (small-cap), SPY (large-cap). This combines different cap sizes for diversification without the active management element that’s required in the market cap rotation strategy. Each index is rebalanced periodically to maintain the market cap target allocation.

Whichever strategy you choose, it’s always important to manage your risk carefully, eg considering correlated assets. As part of doing your due diligence, it’s also useful to use fundamental and technical analysis.

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