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Defining a stock price and market cap
The stock price of a public company and its related market capitalisation are two of the most essential and fundamental terms in equity investment.
QUOTE
All intelligent investing is value investing. Acquiring more than you are paying for. You must value the business in order to value the stock
Big ideas
- A company's overall market cap is determined by the total number of outstanding shares times the price for each share.
- The market cap is an indicator of overall company size. Thus it stands to reason that the biggest companies in the world have the biggest market cap - the very biggest are known as mega caps.
- A company’s stock price is affected by a wide variety of factors. While it is impossible to consistently predict exact stock prices, general movements up or down can be inferred from certain information.
What is a stock price?
DEFINITION
Stocks, also known as "equities", are the most commonly traded investment asset. They are symbolic representations of a company and trade on various exchanges, depending on the location.
Popular stock exchanges include the Standard & Poors 500 Index (S&P500), Financial Times Stock Exchange 100 Index (FTSE100), DAX 40 (GER40), etc.
The stock price is affected by company performance and public perception. Companies publish financial records at given intervals, and the stock price can rise or fall depending on this performance. Macroeconomic events can also affect an entire sector or geographic location, dragging down the price of an otherwise good stock.
Stocks can be owned outright. They can also be a foundation for futures and options, or part of an index or ETF, in which case they may or may not be owned directly by the investors.
The stock price is affected by company performance and public perception. Companies publish financial records at given intervals, and the stock price can rise or fall depending on this performance. Macroeconomic events can also affect an entire sector or geographic location, dragging down the price of an otherwise good stock.
Stocks can be owned outright. They can also be a foundation for futures and options, or part of an index or ETF, in which case they may or may not be owned directly by the investors.
What is market capitalisation and what does it tell you?
DEFINITION
The market capitalisation, also known as "market cap", indicates the overall company valuation. The market capitalisation will tell you how big a company is in financial terms.
Market capitalisation is arguably the most common financial metric available - and that’s out of a gigantic number of available metrics. The formula is merely the stock price by the total number of outstanding stocks.
FORMULA
Market capitalisation = stock price * total stocks
For instance, let’s say there is a company with a stock price of $5 with 100 million stocks outstanding. In this case, the market capitalisation of the company is $500,000,000 ($5 multiplied by 100 million).
At the time of writing (July 2024), the world’s largest company by market capitalisation is Microsoft (MSFT), worth $3.41 trillion. The second largest company by market cap is Apple (APPL) at $3.37 trillion market cap.
Presently, eight of the world’s top ten largest companies by market cap are US-domiciled, and the top five companies are tech stocks - Microsoft, Apple, NVIDIA, Google, and Amazon.
At the time of writing (July 2024), the world’s largest company by market capitalisation is Microsoft (MSFT), worth $3.41 trillion. The second largest company by market cap is Apple (APPL) at $3.37 trillion market cap.
Presently, eight of the world’s top ten largest companies by market cap are US-domiciled, and the top five companies are tech stocks - Microsoft, Apple, NVIDIA, Google, and Amazon.
What factors alter a company's market cap?
A company’s market cap is basically affected by anything that affects its stock price. This can include negative company performance as indicated by its financial statements, rising production costs in the supply chain, or rival companies with superior offerings.
Industry segments can also rise or fall, so the real estate sector, tech sector, or manufacturing sector might be going through a shift, taking all the companies with it.
Industry segments can also rise or fall, so the real estate sector, tech sector, or manufacturing sector might be going through a shift, taking all the companies with it.
Largest Companies by Market Cap (July 2024)
Source: CompaniesmarketcapKeep in mind that the market cap is dynamic and changes second by second, as the share price changes. Also, remember that the stock price alone is no indication of company value. Currently, Microsoft and Apple have nearly identical market cap values, yet Microsoft's stock price is more than double that of Apple's.
Overview of the factors influencing stock price and market cap
A large list of items is responsible for the stock price and market cap, and it is in many ways a dynamic equation. The following headings will break each condition into its appropriate category.
1. Company performance
- Revenue, earnings, and profit margins directly impact stock prices and market cap.
- Strong financial results generally lead to higher stock prices.
2. Economic conditions
- Economic growth tends to boost stock prices, while recessions can lead to declines.
3. Market sentiment
- Investor perception and market trends influence stock prices.
- Positive news can increase prices, while negative news can cause declines.
4. Industry performance
- Sector trends and the performance of competitors impact stock valuation.
- A thriving industry can raise the market cap of companies within it.
5. Corporate actions
- Stock splits, dividends, and share buybacks can affect stock prices.
- Mergers and acquisitions often lead to significant price changes.
6. Regulatory environment
- Changes in laws and regulations can impact business operations and profitability.
- Regulatory challenges or favorable conditions influence investor sentiment.
7. Global events
- Political stability, international trade policies, and geopolitical events can affect stock prices.
- Global crises often lead to market volatility.
8. Technological advancements
- Innovations and the adoption of new technologies can drive stock prices up.
- Falling behind in tech can negatively impact a company’s market cap.
Market cap segments
Market capitalisations can be divided into segments for broad analysis. Companies can move up and down the segments depending on how the share price is performing. You can also invest across segments as a means of diversification, with nano-cap (the smallest small-caps) being the most risky and mega-cap being the least risky.
Mega-cap
Mega-cap stocks are the ones we all know, probably being exposed to their products/services in some way on a daily basis. The market cap of these firms is over $200 billion and these giants include Coca-Cola (CO), Johnson & Johnson (JNJ), Walmart (WMT), JP Morgan (JPM), etc. Such companies enjoy steady growth yearly and are regarded as the safest assets on the market. Even if they have a bad year, they tend to bounce right back but of course are never guaranteed to do so.
Large cap
A large-cap stock has a market capitalisation of over $10 billion. These companies are typically well-established, stable, and leaders in their industries. They often offer lower risk compared to smaller companies, making them attractive to investors seeking steady growth and income through usually well-established dividend or share buyback programs. Examples would include Starbucks (SBUX), Boeing (BA), Netflix (NFLX), and McDonalds (MCD).
Mid-cap
A medium-cap stock typically has a market capitalisation between $2 billion and $10 billion. These companies are often in a growth phase and have established revenues and profitability. They offer a balance between the stability of large-cap companies and the growth potential of small-cap companies. Examples include Etsy (ETSY), Spotify (SPOT), and Block (SQ).
Small cap
A small-cap company is a firm with a market capitalisation typically between $300 million and $2 billion. These companies are usually in the early stages of growth and offer higher potential returns but come with higher risks compared to large-cap companies. They often operate in niche markets or are expanding into new markets. Investors are attracted to small caps for their growth potential, though they should be prepared for greater volatility in stock performance.
Micro-cap
Microcaps have a valuation between $50 million and $300 million. They are the smallest publicly traded firms, meaning that you can buy them on exchanges (even so, you might not find them on all exchanges). Due to their size and volatility, micro-cap stocks can experience significant price fluctuations in response to market conditions and company-specific news.
Nano-cap
Nano-cap stocks are those valued under $50 million. They are not traded on exchanges and are only available over the counter as penny stocks - sometimes known as "pink sheets". These stocks are considered very high risk and the brokers that trade in these stocks tend to be less reputable, with pink sheets trading being rife with hacks and scams. Like micro-cap companies, they are illiquid to trade - meaning wide spreads and a general difficulty in selling due to low volume.
How to consider market cap when investing
When investing, the market cap is a crucial factor to consider as it helps gauge a company's size, risk, and growth potential. Large and mega-cap companies, with a market cap over $10 billion, are typically stable and well-established, offering lower risk but slower growth. These are ideal for conservative investors seeking steady returns.
Mid-cap companies, with a market cap between $2 billion and $10 billion, strike a balance between risk and reward. They are often in a growth phase, providing opportunities for higher returns than large caps but with more volatility.
Small-cap companies, with a market cap under $2 billion, are generally younger and in emerging industries. They offer high growth potential but come with higher risk and volatility. These are suited for investors willing to take on more risk for greater potential gains. This sector also includes micro and nano-caps.
Diversifying investments across different market caps can help balance risk and reward in a portfolio. It allows investors to take advantage of both the stability of large-caps, the growth potential of mid-caps, and the high returns of small-caps. Understanding market cap helps tailor investment strategies to individual risk tolerance and financial goals.
Small-cap companies, with a market cap under $2 billion, are generally younger and in emerging industries. They offer high growth potential but come with higher risk and volatility. These are suited for investors willing to take on more risk for greater potential gains. This sector also includes micro and nano-caps.
Diversifying investments across different market caps can help balance risk and reward in a portfolio. It allows investors to take advantage of both the stability of large-caps, the growth potential of mid-caps, and the high returns of small-caps. Understanding market cap helps tailor investment strategies to individual risk tolerance and financial goals.
Market capitalisation vs. Float-adjusted market cap
Market cap is the total value of a company's outstanding shares. This value is found by multiplying the current share price by the total outstanding shares. It gives a broad view of a company's value in the market.
Float-adjusted market cap, on the other hand, only considers the shares available for public trading, excluding closely held shares owned by insiders, employees, and major shareholders. This measure focuses on the shares that are actually traded in the market, providing a more accurate reflection of a company's liquidity and the market's perception of its value.
For investors, understanding both metrics is important. Market cap offers a general sense of company size and stability, while float-adjusted market cap gives insight into the actual market supply and demand dynamics. Using both can help in making more informed investment decisions, balancing between understanding overall company value and actual market influence.
Float-adjusted market cap, on the other hand, only considers the shares available for public trading, excluding closely held shares owned by insiders, employees, and major shareholders. This measure focuses on the shares that are actually traded in the market, providing a more accurate reflection of a company's liquidity and the market's perception of its value.
For investors, understanding both metrics is important. Market cap offers a general sense of company size and stability, while float-adjusted market cap gives insight into the actual market supply and demand dynamics. Using both can help in making more informed investment decisions, balancing between understanding overall company value and actual market influence.
FORMULA
Free float market cap = share price * number of free float shares
For investors, market cap gives a broad view of a company’s overall value. The free-float market cap provides a clearer picture of the market value of shares that are actually available for trading. This metric is often used in indices to ensure they reflect the liquidity of the stocks included. Both metrics are important but serve different purposes in evaluating and comparing companies.
How do changes in cash and debt impact market cap?
Changes in cash and debt do not directly impact market cap, but they can influence investor perception and stock price. Market cap is the total value of a company’s outstanding shares, calculated by multiplying the share price by the number of shares.
Increased cash reserves can boost investor confidence, potentially raising the share price. This might occur if investors believe the company can fund growth, weather downturns, or return capital to shareholders.
On the other hand, rising debt levels may raise concerns about financial stability. If investors view the debt as a risk, the stock price might fall, reducing the market cap.
Therefore, while cash and debt don't directly alter market cap, they influence investor sentiment, which can lead to changes in stock price and, subsequently, market cap.
Increased cash reserves can boost investor confidence, potentially raising the share price. This might occur if investors believe the company can fund growth, weather downturns, or return capital to shareholders.
On the other hand, rising debt levels may raise concerns about financial stability. If investors view the debt as a risk, the stock price might fall, reducing the market cap.
Therefore, while cash and debt don't directly alter market cap, they influence investor sentiment, which can lead to changes in stock price and, subsequently, market cap.
How a stock price and market cap affects bonds
Stock price and market cap primarily relate to equities but indirectly impact bonds. Market cap, the total value of a company's shares, reflects the company's size and financial health. A larger market cap often signals stability, influencing bond investors' perception of risk.
There is typically a linear relationship to the size of the company and its cost of borrowing, meaning that the bonds issued by large cap companies offer lower yields, whereas small cap companies offer higher yields on their bonds. That’s because a company's stock price and market cap influence its creditworthiness. Higher stock prices and market cap generally indicate better financial health.
Additionally, stock price fluctuations can affect bond prices, especially convertible bonds, which can be converted into stock. If stock prices rise, convertible bonds become more attractive, potentially raising their prices. Conversely, falling stock prices might reduce the attractiveness of these bonds.
There is typically a linear relationship to the size of the company and its cost of borrowing, meaning that the bonds issued by large cap companies offer lower yields, whereas small cap companies offer higher yields on their bonds. That’s because a company's stock price and market cap influence its creditworthiness. Higher stock prices and market cap generally indicate better financial health.
Additionally, stock price fluctuations can affect bond prices, especially convertible bonds, which can be converted into stock. If stock prices rise, convertible bonds become more attractive, potentially raising their prices. Conversely, falling stock prices might reduce the attractiveness of these bonds.
Stock price and market cap: Mutual funds and ETFs
These funds often track indices composed of stocks with varying market caps. For example, an ETF tracking the S&P 500 includes large-cap companies. Stock prices directly influence the net asset value (NAV) of the fund, reflecting the combined value of all stocks held.
In mutual funds and ETFs, market cap determines allocation strategies. Funds may focus on large, mid, or small-cap stocks based on investment goals. Large-cap-focused funds tend to be more stable, while small-cap funds offer growth potential but with higher volatility. Investors choose funds based on their risk tolerance and investment strategy, influenced by the market cap and stock price movements of the underlying assets.
In mutual funds and ETFs, market cap determines allocation strategies. Funds may focus on large, mid, or small-cap stocks based on investment goals. Large-cap-focused funds tend to be more stable, while small-cap funds offer growth potential but with higher volatility. Investors choose funds based on their risk tolerance and investment strategy, influenced by the market cap and stock price movements of the underlying assets.
Recap of stock price and market cap
One of the first things an investor learns when entering the market is the stock price and market capitalisation. It’s a non-negotiable piece of knowledge that leads the way to the whole field of investment.
While predicting the stock price precisely is an impossibility, an understanding of concepts like market cap and how they can assist in diversifying the stocks you own helps balance out long term returns.
While predicting the stock price precisely is an impossibility, an understanding of concepts like market cap and how they can assist in diversifying the stocks you own helps balance out long term returns.
FAQ on stock price and market cap
Q: How to incorporate market cap in your portfolio?
To incorporate market cap into your portfolio, diversify by including stocks from different market cap categories: large, mid, and small caps. This approach balances stability and growth potential. Align your allocation with your risk tolerance; large caps offer stability, while small caps present higher growth opportunities. Regularly review and adjust your portfolio to maintain this balance.
Q: Is a company’s market cap affected by a stock split?
A company’s market cap is not affected by a stock split. While there might be more or fewer shares in the stock split, affecting the price of a single stock, the market capitalisation will remain the same. For instance, for a 2:1 stock split, the amount of stocks will double while the price will halve, maintaining price equilibrium.
Q: How do investors influence stock prices?
Investors influence stock prices by buying and selling shares based on their assessment of a company's financial health, growth prospects, and overall market conditions. Positive news like strong earnings or new product launches can drive demand, pushing prices up. Negative news or economic downturns may lead to selling, causing prices to fall. Institutional investors and analysts' recommendations also play a role.
Q: How important is market cap and stock price?
These are basic investment terms and the starting point for investment. While they are foundational, you’ll need far more in your investment arsenal to become successful over the long term. The market cap is affected by the stock price, which nobody can predict with 100% accuracy. Investing across market cap segments could be a useful way to reduce portfolio volatility.
Q: How do changes in minority interest impact market cap?
Changes in minority interests do not directly impact market cap. However, they can influence market cap indirectly by affecting investor perception and financial statements. Minority interest represents the portion of a subsidiary not owned by the parent company. An increase in minority interest might signal growth or strategic expansion, which could boost investor confidence and stock prices. Conversely, a decrease might indicate consolidation or divestment, potentially raising concerns about the company's strategic direction.
- Outstanding shares: The total number of a company’s shares that are issued and held by investors.
- Over-the-counter (OTC): A method of trading securities directly between parties rather than on a formal exchange.
- Stock splits: A process where a company increases its number of outstanding shares by dividing existing shares into multiple new ones, thereby lowering the individual share price without changing the company’s total value.
- Share buybacks: When a company repurchases its own shares from the open market, reducing the number of shares available and often aiming to boost the stock price.
- Value investing: An approach focused on buying shares believed to be underpriced relative to their intrinsic worth, with the anticipation of profiting once the market recognises their true value.
