Market capitalization: what it is and how it works

There are many ways to help you determine the value of a business, and the easiest way is to look at the market value of the company (also known as market capitalization). However, not everyone knows how to evaluate and understand what market capitalization is. In the following article, we will provide the most basic information about market capitalization and what it means to invest in stocks.

What is market capitalization?

Market capitalization measures the size of a company, determined by the total amount of money spent on buying back the entire company under current conditions.

The formula calculates the market capitalization:

Market capitalization = number of shares x market price of 1 share

Example: A company with 20 million shares sold for $100,000 per share would have a market cap of $2 trillion.

Stock prices will depend on many factors such as profitability, assets, risk, prospects and crowd sentiment. Therefore, depending on the performance of the company or the movements in stock prices, the market capitalization may change. When the stock price rises, the market capitalization also increases. When the stock price falls, the company’s market capitalization also decreases.

Why is market capitalization important?

Investors often look to market capitalization as a benchmark factor in investment decisions when participating in the stock market.

In particular, market capitalization tells us how big or small a company is, thus determining the value of the industry and the actual value of a security traded on the market. Based on these factors, investors can decide whether to invest or not.

In addition, market capitalization is also influential in determining the level of risk and growth potential of a company. The higher the capitalization, the lower the risk and vice versa. The smaller the capitalization, the greater the risk.

To make it easier to imagine, think of a tree: big trees represent large-cap businesses, small trees represent small-cap businesses. Comparing the level of risk, it is clear that large trees are better able to survive and cope with nature than small trees. However, in terms of future growth potential, small trees are more likely to increase and develop.

The stock market is similar. A company with a large market capitalization will be the safest choice for investors due to its sustainability and stable income. Smaller companies with small market capitalization offer more attractive profit opportunities due to their ability to increase from start-ups.

Classification of shares by market capitalization

Ordinary shares are classified according to market capitalization as follows:

  • Micro-cap: The market capitalization of the business is less than $250 million. These are actions of small businesses with an extremely high level of risk.
  • Small-cap: A company’s market cap ranges between $250 million and $1 billion, it’s a stock of young companies with significant growth potential but the risk of failure. The failure is also relatively large.
  • Mid-cap: A company’s market cap ranges between $1 billion and $5 billion. Company shares are expected to grow rapidly and have low risk compared to small-cap stocks.
  • Large-cap: market capitalization of a business between $ 5 billion and $ 25 billion, referring to large companies with constant growth and low risk, such as Wal-mart, Microsoft.
  • Mega cap (also known as super cap): A company’s market cap of more than $25 billion, refers to the largest companies in today’s financial markets, such as Berkshire Hathaway, Google, Amazon, General Electric, and Exxon Mobil.

These numbers will also change over time because the stock market will always appreciate in the long run and the capitalization of companies will grow.

While market cap is a significant factor in making investment decisions, that’s not all. As a smart investor, you need to use a combination of information, technical analysis, and fundamental analysis to determine a good and profitable stock.

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