What Is Market Cap?
Market capitalization, often referred to simply as ‘market cap’, is an important metric in investing. Whether in stocks or in crypto, investors can’t do proper fundamental due diligence without understanding how market cap is calculated — and why it is important.
Why Is Market Cap Important?
Market cap is important for many reasons. First, from a purely financial standpoint it essentially defines the success of the corporation. Market cap is the equity value of the company; looked at another way, it is the total value (on paper) of all of the shareholders’ holdings.
In addition, it’s difficult to properly analyse a stock’s fundamentals without at least a grasp of market cap. Per-share figures can be used to calculate, for instance, a price-to-earnings multiple. But market cap is necessary to put into context absolute figures like free cash flow or EBITDA (earnings before interest, taxes, depreciation and amortisation).
Market cap is even necessary to put a stock’s price into context. A cheap share price doesn’t necessarily make a stock cheap. A company could have a share price of £3 — but if there are 1 billion shares outstanding, the stock may be far more expensive than the per-share price suggests.
For crypto, too, market cap is useful. A coin may have a low price in dollars (or in many cases, cents), and thus seem ‘cheap’. But if there are tens of billions of coins in circulation, a market cap in the billions may not be supported by the cryptocurrency’s use case.
Indeed, to oversimplify, the point of even being a public company, or developing a useful cryptocurrency, is to increase market cap. And investors can’t properly choose the companies that will drive those increases without understanding exactly what market cap is, and what it means.
How Is Market Cap Calculated?
In stocks, market cap is calculated by multiplying the number of shares outstanding by the share price. There are some potential adjustments to this basic calculation, but the standard definition of market cap focuses solely on outstanding shares. If there are 1 million shares outstanding, and the share price is £100, the market cap (or equity value) totals £100 million.
Market cap in crypto uses a similar calculation: coin price multiplied by circulating coins. Note that the circulating supply is not the same as the maximum supply. For instance, Bitcoin (BTC) has a maximum supply of 21 million, but not all of those coins have yet been mined.
Is Market Cap The Same As Valuation?
Sometimes, but not always. “Valuation” is a term with broad usage in investing. It can refer to the market cap of a publicly-traded company. But it can also cover fundamental analysis more broadly.
An investor might say, for instance, that a stock has an attractive valuation. By implication, that refers to market cap, but the statement focuses more broadly on the stock’s fundamental attributes.
For clarity’s sake, investors are best off using the correct term “market cap” instead of the less-focused “valuation”.
How to Calculate Enterprise Value From Market Cap?
Market cap is equal to the value of the outstanding equity of a publicly-traded company. But it is not equal to the entire value of the company. For that, investors need to use enterprise value.
The calculation for enterprise value is simple: market cap plus outstanding debt less cash on the corporation’s balance sheet.
An example of how to calculate enterprise value from market cap: ABC Corporation has a market capitalization of £1 billion. It has £500 million in debt outstanding, and £100 million in the bank. ABC’s enterprise value is thus £1 billion plus £500 million minus £100 million — or £1.4 billion.
A company can have “net debt,” in which debt on the balance sheet is greater than cash in the bank. Conversely, it can have “net cash,” in which its cash hoard is greater than its outstanding debt.
A company with net debt will have an enterprise value greater than its market cap. A company with net cash will have an enterprise value less than its market cap. In fact, though it’s rare, a company can in fact have a negative enterprise value, which simply means that net cash is greater than the market capitalization.
Again, market cap values a company’s equity. Enterprise value values the entirety of the company — the operating business as well as cash and debt.
How Does Market Cap Affect Stock Price?
Market cap does not affect stock price. The stock price affects the market cap. Again, market cap is defined as the sum of outstanding shares multiplied by the stock price. The market cap is moved by the stock price, not the other way around.
What Is Free Float Market Cap?
Free float market cap is calculated using only the outstanding shares that trade freely in the market. Those exclude shares held by governments, executives, or other parties that may be restricted from transferring their holdings.
Free float market cap is not a commonly used metric in fundamental analysis. It’s more commonly used by index providers.
At the end of 2021, in an effort to remove a perceived barrier to listing stocks in the UK, the FCA reduced the free float minimum requirement (percentage of listed shares of a company in public hands) from 25% to 10%.
What Is Fully-Diluted Market Cap?
Fully-diluted market cap, however, can be an important part of fundamental analysis. Again, market cap on a stock is calculated by using shares outstanding. But there may be ownership interests that don’t yet count as outstanding shares. Those interests may become outstanding shares at some point in the future, adding to outstanding shares. Those new shares will “dilute” the ownership of existing shareholders.
One common category is stock options held by executives. Those options may be “in the money”, meaning that the executives can exercise the option to buy the stock for less than the share price. But they also may not have vested, or become exercisable, usually because not enough time has elapsed.
Another is warrants. Special purpose acquisition companies, or SPACs, are shell companies used to bring private companies to the public market. SPACs almost always provide warrants to investors that are valid for as long as five years after the SPAC merges with the target company. Other companies may issue warrants as well, often in the process of raising capital.
Whether options or warrants, investors often adjust market cap to account for the dilution caused by future share issuance. If XYZ Corporation has 50 million shares outstanding and a share price of £10, its market cap is £500 million under the standard calculation. But if there are 10 million options and 10 million warrants “in the money”, the fully-diluted market cap is £700 million.
It’s worth noting that fully-diluted market cap can lead to a calculation of fully-diluted enterprise value as well. That calculation should account for the cash infusion from option and warrant exercise.
To return to our example, XYZ has a £500 million market cap. The company has £100 million in cash, and no debt. Its enterprise value thus is £400 million.
Assume the options and warrants have a strike price of £5 (i.e., the option and warrant holders pay £5 per share for the stock valued at £10). Those options and warrants will each bring in another £50 million in cash (as the £5 strike price for the 10 million options and the 10 million warrants will be paid to the company).
Our fully-diluted enterprise value, then, begins with a fully-diluted market cap of £700 million. Existing cash is £100 million, and warrants and options will bring in another £100 million in total. XYZ has a fully-diluted enterprise value of £500 million, against £400 million using the standard calculation.
What Makes Market Cap Go Up?
The simplest way for market cap to go up is for the stock price to rise. But since market cap equals stock price multiplied by shares outstanding, a higher share count can increase market cap as well.
This was seen most notably with many so-called “meme stocks” in 2021. Many companies took advantage of their soaring stock prices by selling stock directly to investors — and thus increasing the number of shares outstanding. As a result, their market caps increased not just due to the higher share price, but to a greater number of issued shares as well.
Many companies do see a smaller, steadier increase in share count over time — often due to the exercise of the aforementioned stock options. Other companies repurchase stock, leading to a lower share count. It’s possible, though rare, for a company to see its share price rise while its market cap decreases thanks to share repurchases.
What Is Market Cap On A Stock?
The market capitalization of a stock is the sum of the value of the outstanding shares.
Is Equity Value The Same As Market Cap?
Yes, the two terms can be used interchangeably.
What Is Market Cap In Crypto?
Market cap in crypto is similar to market cap of a stock. In crypto, market cap is defined as the sum of the value of the coins in circulation.