A company's worth—orits total market value—is called its market capitalization, or market cap. A company's market cap at any given time can be determined by multiplying its stock price by the number of shares outstanding.
Therefore, any significant change in a stock price results in an equal percentage change in the company's market cap. This is one of the reasons why investors are so concerned with stock prices. A $0.10 drop in a stock price results in a $100,000 loss on paper for a shareholder with one million shares.
Key Takeaways
- A company's market capitalization—also called its market cap—is a straightforward measure of the company's market value.
- Market cap is calculated by taking the current share price and multiplying it by the number of shares outstanding.
- For example, a company with 50 million shares and a stock price of $100 per share would have a market cap of $5 billion.
- Stocks are often classified according to the company's respective market value, Big caps are companies that have a large market value while small caps have a small market value.
How Is Share Price Determined?
Broadly speaking, prices in the stock market are driven bysupply and demand. This makes the stock market similar to other economic markets. When a stock share is sold, a buyer and seller exchange money for share ownership. The price for which the stock is purchased becomes the new market price. When another share is sold, this price becomes the newest market price.
There are various techniques and formulas that can be used to predict the future price of a company's shares. Calleddividend discount models (DDMs), they are based on the concept that a stock's current price equals the sum total of all its futuredividend payments (whendiscountedback to their present value). By determining a company's share by the sum total of its expected future dividends, dividend discount models use the theory of the time value of money(TVM).
A company's market capitalization is calculated by multiplying its share price by the number of shares outstanding:
Market Capitalization = share price x number of shares outstanding
A company's market cap is first established in an initial public offering (IPO). In preparing for this process, a company pays a third party (typically an investment bank)to determine the value of a company, and recommend how many shares to offer to the public and at what price. For example, a company whose value is estimated at $100 million may want to issue 10 million shares at $10 per share.
Once a company goes public and its shares start trading on a stock exchange, its share price is determined by supply and demand in the market. If there is a high demand for its shares, the price will increase. If the company's future growth potential looks dubious, sellersof the stockcan drive down its price.
For example, suppose that Microsoft (MSFT) is trading for $71.41 on Sept. 8, 2022, and has 7.7 billion shares outstanding. Assume also that the company is valued at $71.41 x 7.7 billion = $550 billion. Meanwhile, Meta (META), formerly Facebook, has a $162.06 stock price and 2.69 billion shares outstanding (market cap = $435.5 billion). As of this date, Meta is worth less than Microsoft.
Misconceptions About Market Capitalization
Although it is often used to describe acompany (e.g., large cap vs. small cap), market cap does not measure the equity value of a company. Only a thorough analysis of a company'sfundamentals can do that.
Market capitalization is an inadequate way to value a company because its market price is not necessarily a reflection of how much a piece of the business is worth. Shares are often over- or undervalued by the market.
Market price shows only how much the market is willing to pay for its shares, not how much it is actually worth.
Even though market cap measures the cost of buying all of a company's shares, it does not determine the amount the company would cost to acquire in a merger transaction.
While market cap is often used synonymously with a company's market value, market cap really refers only to the market value of a company's equity, not its market value overall, which would include the value of its debt or assets.
FAQs
Market capitalization, or market cap, is the total value of a company's shares of stock. If a company has issued 10 million shares, and its share price is $100, its market cap is $1 billion. Market cap is calculated by multiplying the number of stock shares outstanding by the current share price.
How does a company determine its stock price? ›
What determines stock prices? The price of a stock is largely determined by supply and demand. If demand is high, the price tends to go up, and if supply is high, the price tends to go down.
How is the stock price determined? ›
Stock prices are largely determined by the forces of demand and supply. Demand is the amount of shares that people want to purchase while supply is the amount of shares that people want to sell.
How do you calculate market cap vs price? ›
Market Cap Formula
To calculate the market capitalization of a company, the company's latest closing share price is multiplied by its total number of diluted shares outstanding.
What is a good market cap for a stock? ›
Sizing up stocks
Large-cap: Market value of $10 billion or more; generally mature, well-known companies within established industries. Midcap: Market value between $3 billion and $10 billion; typically established companies within industries experiencing or expected to experience rapid growth.
Who sets the price for a company's stock? ›
Stock prices are set by what's known as the secondary market, which is the technical term for investors trading shares among themselves. This is opposed to the primary market, when a company sells shares of stock directly to investors. A stock's price is set by supply and demand in a secondary market.
What is the formula for calculating the stock price? ›
We can calculate the stock price by simply dividing the market cap by the number of shares outstanding. Let's now think about why we can calculate it this way. The Market Cap (aka Market Capitalization) reflects the market value of the equity of the company.
Who actually changes the stock price? ›
Stock prices change everyday by market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up.
How is market stock price calculated? ›
Stock prices are determined by the relationship between buyers and sellers, and dictated by supply and demand. Buyers “bid” by announcing how much they'll pay, and sellers “ask” by stating what they'll accept. When they agree on an amount, it becomes the new stock price.
How does market cap affect stock prices? ›
Market cap does not affect stock price; rather, market cap is calculated by analyzing the stock price and number of shares issued. Although a blue-chip stock may perform better because of organizational efficiency and greater market presence, having a higher market cap does not directly impact stock prices.
Market capitalization, or market cap, is the total value of a company's shares of stock. If a company has issued 10 million shares, and its share price is $100, its market cap is $1 billion. Market cap is calculated by multiplying the number of stock shares outstanding by the current share price.
What is the market cap formula? ›
To determine a company's market cap, simply take its current market share price and multiply the figure by the total number of shares outstanding.
How is market cap rate determined? ›
Calculated by dividing a property's net operating income by its asset value, the cap rate is an assessment of the yield of a property over one year. For example, a property worth $14 million generating $600,000 of NOI would have a cap rate of 4.3%.
What increases a stock price? ›
Key Takeaways
Stock prices are driven by a variety of factors, but ultimately the price at any given moment is due to the supply and demand at that point in time in the market. Fundamental factors drive stock prices based on a company's earnings and profitability from producing and selling goods and services.
How to understand market cap? ›
Market cap is the total dollar value of a company's outstanding shares of stock. For example, if a company has 1 million shares of outstanding stock and the stock currently trades at $50 per share, then its current market cap is $50 million.
What is a good amount to have in the stock market? ›
Generally, experts recommend investing around 10-20% of your income. But the more realistic answer might be whatever amount you can afford. If you're wondering, “how much should I be investing this year?”, the answer is to invest whatever amount you can afford!
Do companies get to choose the price of their stock? ›
Once a company goes public and its shares start trading on a stock exchange, its share price is determined by supply and demand in the market. If there is a high demand for its shares, the price will increase.
Do companies set their own stock price? ›
The price is set based on valuation and demand from institutional investors. After the initial offering, the stock starts to trade on secondary markets -- that is, stock exchanges such as the New York Stock Exchange (NYSE) or the Nasdaq. This is where we get into the market being a voting machine.
What determines how much stock a company has? ›
The number of authorized shares per company is assessed at the company's creation and can only be increased or decreased through a vote by the shareholders. If at the time of incorporation the documents state that 100 shares are authorized, then only 100 shares can be issued.
How do you determine the real price of a stock? ›
The most common way to value a stock is to compute the company's price-to-earnings (P/E) ratio. The P/E ratio equals the company's stock price divided by its most recently reported earnings per share (EPS).
