Market Capitalization: Cap that sits atop the Stock Market

22 Feb 2021  Read 271 Views

If you have been regularly following the news, you might be aware that currently, RIL is the largest company in India, followed by TCS and others. But how was this decided? What caused RIL to become number one?

Well, Reliance Industries Limited was named as the largest company in India in terms of market capitalization.

So what is market capitalization?

It's a common term that is used quite frequently in the stock market and is used to classify companies as small, large or medium. The market capitalization of a company is often seen as the valuation of that company.

Hence, it is important for every investor to understand what market capitalization is so that the next time they judge a company based on its size, they will be aware of the entire picture behind it.

What is Market Capitalization? 

The market capitalization of a company is the total market value (current market price in the market) of its outstanding shares (shares owned by all the promoters, investors, etc., in the public domain). 

The companies are categorized into large-cap, mid-cap and small-cap based on their market capitalization. 

Market capitalization is used by investors and traders to evaluate the company's value. The investor gives ranking to the companies based on their market capitalization and can compare them with their peers in the market segment: 

Market capitalization has the following implications in the stock market:

  • The market cap affects the index like NIFTY50. Supposedly, if HDFC Bank's market cap increases enormously, then simultaneously its weight in the index will also increase. 
  • The market cap helps in comparing two companies in the same segment. For instance, TCS has more market cap than Infosys, so it suggests that TCS is bigger than Infosys. 
  • Investors try to balance their portfolio with a proper mix of large-cap, mid-cap, and small-cap companies. Market capitalization is the basis of these categories.
  • The market cap also indicates the risks associated with the company. Although it does not give a real picture of the risk, but a company with a larger capitalization than its competitor shows that investors and shareholders believe that the risk associated is low as compared to its peers and that the company may give good returns in the future.
  • The market capitalization method is applicable in all the share markets around the globe. This facilitates investors in evaluating companies in the known as well as unknown markets. 

How to calculate Market Capitalization? 

The market capitalization of the company is calculated by the following formula:

Market Capitalization = Total Outstanding Shares × Current Market Price  

*Outstanding shares refer to the shares of the company currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by its officers and insiders. 

Let us understand this with an example:

Suppose there is a company X with 10,000 total outstanding shares, with the current value of each share being Rs.20.

Hence, based on the above formula, the market capitalization of company X will be;

Rs (10,000×20) = Rs. 2,00,000

What is a Free-float Market Cap? 

While Calculating free-float market capitalization, the shares which are held by private parties like promoters, trusts and government are excluded. Free float is the actual number of a company's stocks that are available in the open market for public trading.

The free-float market capitalization is the total market value of the free float shares of the company. The free-float factor aims to distinguish the controlling shareholding and the shareholders whose shareholding depends on the prospects of the company, share price and risk associated.

The free-float market cap excludes following the shareholdings:

  • Locked-in shares 
  • Shares held by the promoters 
  • Shares held by the governments 
  • Shares held by the FDI route 
  • Strategic shareholdings 
  • Shareholding of Employee Welfare Trusts 
  • Shareholding of associated company (cross-holding between companies) 

Free float market capitalization is used by the stock exchanges like BSE and NSE to compute their indices like NIFTY50, S&P Sense, etc. 

Say, a free float of 0.50 in BSE will determine that 50% of the shareholding will be considered for free-float market capitalization. 

The free-float factor is inversely related to volatility. A company with a large free float size will be less volatile. On the other hand, a company with a small free float size will be highly volatile. 

What is Full Market Cap? 

Full market capitalization is in which all the outstanding shares of a company are considered while calculating its market capitalization. It is the original method of calculating the market capitalization of a company.

Full market cap includes free float shares as well as non-free float shares such as promoter's shareholding

                      

Difference between Free Float Market Cap And Full Market Cap

Free Float market cap 

Full market cap 

It considers shares which are actively available in the open market.

It includes all the outstanding shares of the company.

The volatility of the stock can be figured out. 

The volatility of the stock cannot be figured out.

It is majorly considered for the computation of indices.

It is not widely used for the computation of indices.

It is a recent concept.

It is the original concept.

It does not include promoters and locked-in shares.

It includes promoters and locked-in shares. 

It does not include the shareholding of the controlling element of the company.

It includes the shareholding of the controlling element of the company.

Closing Words 

Understanding the value of a company is a crucial factor for an investor, which should be considered before investing. Market capitalization helps the investor in figuring out the valuation of the company. You need to understand the crux behind market capitalization if you are an investor, and in India, this is a lot easier due to the easy availability of company data.

Even though the market cap shows the valuation of a company, it cannot be the sole factor to drive an investment decision. A market cap may hide crucial information like the risk associated with the company. 

Hence it is advisable to do a thorough analysis before investing with the help of all the various methods, ratios, and other instruments in order to choose your ideal investment according to your financial goals. 

About the Author: Harshit Roy | 34 Post(s)

Harshit Roy is a BMS student at St. Xavier's College, Kolkata majoring in finance. He is bibliophile in nature, and quite eager to learn and read about new things in life.

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