Market Capitalization and its importance to investors 

Meaning

Market capitalization is the product of the market price of a share and the number of equity shares outstanding as of the day of calculation. 

It is denoted as market cap. It is one of the important characteristics of a company. 

It is one of the important tools for potential investors in analyzing the risk of the stock.

Based on market capitalization, the companies may be categorized as Large Cap, Mid Cap, and Small Cap.

1. Large Cap: These companies are usually reputable, stable, and well established having a large market share. The stocks of Large Cap have low volatility as compared to Mid Cap and Small Cap stocks so the risk associated with investing in stocks of Large Cap is low. The disadvantage of investing in Large Cap stock is that it has very low growth potential. 

2.     Mid Cap: Volatility is higher than in Large Cap stocks so the risk of investing in Mid Cap stocks is also higher. However, this is compensated by the higher growth rate of Mid Cap stocks.

3.  Small Cap: Volatility is the highest so the risk of investing in Mid Cap stocks is also the highest. However, Small Cap stocks have a considerable growth rate.

 

Importance to potential investors

1.     It helps to understand the company’s structure, profitability, and stock values

2.     It can be used to determine key performance metrics such as Price-to-Earnings, Price-to-Free Cash Flow, Price-to-Book Value, and Enterprise Value to EBIT (Earnings Before Interest and Taxes). Read more about ratios.

Cash flow ratios

Profitability indicator ratios

Important determinants of financial performance of banks

3.     It allows potential investors to understand the true worth of companies.

4.     It allows potential investors to compare the size of one company to other companies.

5.     It is an important tool in predicting the future of the stock of a company because it reflects what the market is willing to pay for the stock.

6.     The knowledge of the market cap helps investors to make decisions about various stocks that they want in their portfolios to their investment objectives.

7.     When there are changes in the economy the Large Cap, Mid Cap, and Small Cap stocks are differently affected, hence these stocks have the potential to lead the market over a long period. So the investors who prefer to have diverse portfolios will be protected from the probable loss due to the changes in the economy.

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