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Market capitalization

From Academic Kids

Market capitalization, often abbreviated to market cap, is a business term that refers to the overall value of a company's stock. In essence, it is the price one must pay to buy an entire company (putting aside that trying to buy an entire company off the market would cause immense price distortions, and takeovers are almost always at more than market price). The size and growth of a company's market capitalization often is one of the critical measurements of a public company's success or failure.

Market capitalization is calculated by multiplying the number of shares of the company and the current price of those shares. The term capitalization is sometimes used as a synonym of market cap; other times, it denotes market cap plus long term debt.

The total market capitalization of all the companies listed on the New York Stock Exchange is greater than the amount of money in the United States.

Contents

Valuation

Main article: business valuation

Market cap is the price of a company's stock, and may not accurately reflect the fundamental situation of the company, because it is significantly dependent on assumptions about the future. It is not uncommon for a company's market cap to be many times larger than the company's "book value" (shareholders' equity) or earnings, if there's anticipation of earnings growth. For instance, in the late 1990s the shares of Internet-related companies were highly valued by the market, and tiny companies with almost no sales (but high growth) had market caps of billions of dollars.

The first reason for a "high" market cap is the fundamental reason (see fundamental analysis), which is anticipation of future growth in cash flow from the operations that the company carry out to add value and earn money in the marketplace. The second reason is price increase from pure speculation of higher price, perhaps because of a large price increase in the past, or because of technical analysis. A third uncommon reason for price increase beyond anticipated returns is government intervention, government buying shares.

Time horizon

The difference in time horizon for investments made on "fundamental" and "speculative" grounds is usually a longer horizon (more than a year) for fundamental reasons, while speculation are obviously in most cases made with a time horizon of less than a year. Selling a share short even has the word "short" in its name in reference to the time horizon of the investment.

"Float"

The amount of shares available on the open market, the "float" (or "free float") is sometimes less than the total number of shares because a portion of the outstanding shares may be held by "insiders," and a portion of shares may be held by the company as treasury stock. And in addition to the float being perhaps much smaller than the total number of shares, a large portion of the float may be owned by large institutional investors who don't trade often. As a result, on any given trading day, generally only a small percentage of shares is traded, as in the example of Yahoo!, about 1.5% (20,025,727/1,180,000,000).

If all company stock became available on the open market all at once, as a result of both the insiders and the company selling all its shares, the price may plummet, if it's unexpected and hasn't already been priced in the stock price. Usually insiders don't hold more than a few to perhaps 10% of its own stock. And the treasury stock is almost always smaller than that.

Categorization of companies by market cap

In the U.S. companies and stocks are often categorized by market cap values as follows (figures given are approximate):

  • Small-cap: a company whose market cap is less than $500 million
  • Mid-cap: a company whose market cap is between $500 million and $1 billion
  • Large-cap: a company whose market cap exceeds $1 billion

Less used are the following terms:

  • Micro-cap: a company whose market cap is less than $300 million
  • Nano-cap: a company whose market cap is less than $50 million
  • Mega-cap: a company whose market cap exceeds $200 billion

Blue chip is used as a synonym for large-cap.

Examples

Examples of share valuation compared to market cap (price), and share ownership, from Yahoo! Inc. ([1] (http://finance.yahoo.com/q/ks?s=YHOO), [2] (http://finance.yahoo.com/q/mh?s=YHOO))


Valuation measures


Share statistics

Buyouts

Main article: Takeover

In large corporate takeovers, the buying company usually either buys a controlling interest from institutional investors or venture capitalists at a discount (in cash), or, more commonly, pays for the shares of the second company in kind; i.e. in shares in itself. This allows the former owners (who now own stock in the controlling company) to sell off the shares bit-by-bit, so as to not ruin the price by dumping.

The opposite case, the book value of the company being more than the market cap, is typically more rare (selling shares is a method of raising money, after all). However, periodic dips in the market and other effects can result in such inversions of the market cap, making the company in question a target for the corporate raider.

Levels

Main article: Equity levels and flows

Stock market capitalisation 2003 (compared with GDP converted to € through estimated purchasing power parity exchange rates)

  • EU: €6.0 trillion (59% of PPP GDP)
  • Japan: €2.4 trillion (75% of PPP GDP)
  • United States: €10.7 trillion (108% of PPP GDP)

See also

Lists

External links

Data

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