Back to learning together again with an amateur like me who is just trying to guide and help other amateurs’ learning journey (in investment) easier. In today’s article, we are going to talk about market capitalisation and also capital markets.
These terms might sound confusing at first glance but not to worry, we will explore those terms soon. As much as the concept of these terms is simple, it is still good to know about them as learning and broadening your knowledge is always a good thing.
You would probably have heard about these terms if you are into investment and somehow keep on reading or watching news about it. However, you might not understand exactly what they mean. Here I am, trying to help you understand better about the two terms.
So let’s get started!
Market Capitalisation
Market capitalization is commonly called market cap. Perhaps you have heard this term when you are reading or watching news. So what is it then? What’s so important about it? Why do you keep on hearing market cap this or market cap that?
By definition, market capitalisation means the total market value of a publicly traded company based on its total outstanding shares.
Total market value? Publicly traded company? Outstanding shares?
A publicly traded company is a company that is publicly listed on a stock exchange like NYSE (New York Stock Exchange) in which the company’s shares can be freely traded.
The total market value simply means how much the company is worth.
Meanwhile, outstanding shares refer to the total number of shares that have been authorized, issued, and actively held by investors or stockholders.
Therefore, market capitalization simply means how much a company is worth based on its total stock values.
Now, if you notice, the outstanding shares have to be authorized first which means they are the number of shares that are authorized to be issued. The issued number of shares cannot be beyond the one that has been authorized. Then they are distributed.
With that said, there are also the shares that are called authorized shares and floating shares. Authorized shares refer to the maximum number of shares that a corporation is legally permitted to issue. It includes already-issued stock, along with shares that have the management’s approval but have not, yet, been released onto the trading market which includes stock options. Outstanding shares are then the ones that include those held by stockholders since they are already released. Floating shares, though, strictly mean the number of shares that are actually available for trading on the market.
Anyway, with the definitions being cleared, now how do we determine the worth then? How is the calculation done?
Market_Cap = Share_Price x Number_of_sharesSo basically, to calculate the market capitalisation, simply multiply its share price with its total number of outstanding shares.
For example: if a company has $10 million outstanding shares and its closing price per share is $10, then its market cap would be $100 million. If its closing price somehow rises to $12, the market cap would be $120 million. If it drops to $5, its market cap would be $50 million.
So that’s it. A simple calculation to determine the worth of a company. It is also used as a determining factor in some forms of stock valuation.
Why? This is because the market cap value determines the size of the company in which it can determine the potential of the company to investors.
For example, a large company would usually be assumed to be safer due to their longevity and stability. On the other hand, a small company would naturally be deemed risky although it might have crazy growth that can double or triple investors’ money in a very short time. Basically, it also sort of depicts how old companies might be more stable as compared to younger companies who are riskier but can produce higher rewards.
Now, how do we know whether a company is large or small based on its market cap?
Traditionally, there were only three levels: large cap, mid cap, and small cap. However, later on three more terms were added: mega cap, micro cap, and nano cap. Personally, I only hear more frequently of these additional terms in trading. Perhaps it might be due to my readings but anyway, the more divisions there are, the more accurate your categorisation can be.
There are no exact cutoff values, but here is the summary of it (though this might vary from one resource to another):
So, the level of the market cap typically correlates to the company’s associated investment risk. As such, you can use it as one of the ways to determine what companies to invest in. You can also try to diversify by investing in different market caps that have different risk levels. Nano cap would have the highest risk while mega cap would be the most stable one.
Capital Markets
Now that you have understood about market capitalisation, let’s move on to the topic about capital markets (yes, it sounds very similar to market capitalisation but they are not the same).
Well, of course capital markets, by definition, have nothing to do with market value or market cap. Capital markets are places where funds are exchanged between people or institutions with money to lend (invest) and those (like businesses, governments, individuals) who seek capital for their use. So basically, those who need to raise funds to do something would issue things like equities (stocks) or debt securities (bonds) for investors through these markets.
The markets, though, can be divided into two: primary and secondary markets. The most common capital markets are the stock market and the bond market.
Secondary market is the market that most people would be familiar with the most. It is the market where trading between investors happens in a regulated way like NYSE or NASDAQ. This also means that the shares issued are usually existing issues.
For example, if a company goes public (IPO) and is listed in an exchange like the NYSE or NASDAQ, the activity of buying or selling the shares from the original investors will take place in this secondary market.
On the other hand, the primary market is the market in which newly issued securities are traded directly in a sense.
For example, if there is a startup that gets an investment from investors by directly buying their shares or ownership of N%, this is considered as activity under the primary market. Basically investors are investing directly from the founders.
By the way, if you would like to know more about stocks, bonds, equities, securities, or any other asset classes or investment vehicles, you can read more here.
More facts on capital markets:
Capital markets are typically concentrated in the financial hubs like New York, London, Singapore and Hong Kong.
These markets may include the stock market, the bond market, and the currency and foreign exchange markets.
Also, financial markets are different from capital markets fundamentally speaking. Capital markets, as explained, are primarily places for firms usually to raise funding to be used in operations or for their growth or whatever activities. Financial markets, on the other hand, are markets where all trades involving financial assets happen.
This means that financial markets cover any assets, securities, etc. Imagine it this way: stock and bond markets are subsets of capital markets, and capital markets are subsets of financial markets. Something like that.
Wrap-Up
Basically, new capital is raised in the primary market, where investors bought the issued stocks and bonds (examples). Then, subsequently, traders and investors would trade (buy and sell) those securities on the open market or secondary market.
Then, when you want to invest in a firm through a market, you would do your own research before investing or trading. Market capitalisation can be one of your factors in investing. For example, if you prefer more stable companies for investment, you can perhaps start researching from the large or mega cap category.
Alright, that’s all for this article. If you find this article helpful, feel free to share with anybody that you think can benefit from this.
Thanks for reading.
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