Market Capitalisation – Basics, Definition & How to Calculate

What is market capitalisation?

Market capitalisation is a company’s aggregate valuation based on its current stock price and the total number of outstanding shares. You can determine market capitalisation by multiplying a company’s current share price by the firm’s total number of outstanding shares. 

Analysts and investors use market capitalisation to categorise and compare the size of companies. For example, companies are classified as large-cap, mid-cap and small-cap depending on market capitalisation. 

According to SEBI, listed companies ranked from 1st to 100th depending on market capitalisation are called large-cap. Moreover, listed companies ranked from 101st to 250th are called mid-cap, and those ranked from 250th onwards are called small-cap.

How to calculate market capitalisation?

You can calculate market capitalisation by multiplying the current share price with the total number of outstanding shares issued by the company. 

Market Capitalisation = Current market price of each share * Total Number of outstanding shares of the firm. 

For example, a company has three crore outstanding shares, and each share’s current market price is Rs 300. The company’s market capitalisation would be 3,00,00,000 * 300 = Rs 900 crore. 

Let’s understand market capitalisation with another example. Suppose a company has two crore outstanding shares, and the current market price of each share is Rs 200. The company’s market capitalisation would be 2,00,00,000 * 200 = Rs 400 crore.

What are the different types of market capitalisation?

• Large-cap companies have a market capitalisation of Rs 20,000 crore or more. These are well-established companies with a significant market share. 
• Mid-cap companies have a market capitalisation ranging from Rs 5,000 to Rs 20,000 crore. These are fast-growing companies where the top management focuses on expansion to grow the firm’s market share. 
• Small-cap companies have a market capitalisation below Rs 5,000 crore. They have the potential to grow rapidly but may struggle to sustain themselves during an economic slowdown.

Types	Market-Cap
Large-Cap	> 20,000 Crore
Mid-Cap	Rs 5,000 Crore to Rs 20,000 Crore
Small-Cap	< Rs 5,000 Crore

What is the importance of market capitalisation?

Market capitalisation helps you predict the future price of a company’s share as it reflects what the market is willing to pay for the share. Moreover, market capitalisation indicates the size and performance of India’s stock market. 

For instance, the market capitalisation ratio to India’s Gross Domestic Product (GDP) shows whether the stock markets are undervalued or overvalued. 

Market Capitalisation to GDP Ratio = (Value of all listed stocks in a country) / (GDP of the country) * 100

According to this thumb rule, if the stock market capitalisation to GDP is between 50%-75%, stock markets are said to be modestly undervalued. If the ratio is between 75%-90%, stock markets are said to be fair valued. However, the stock markets are said to be modestly overvalued if the ratio is between 90% and 115%. 

• Market capitalisation to GDP Ratio, called the Buffett Indicator, shows the stock market valuation at any time.
• If the Buffett Indicator is high, it shows that companies’ output is low compared to their valuations on the stock market. 
• Suppose the Buffett Indicator moves far ahead of its long-term averages; it signals a likely market correction as optimism levels are too high among market participants. 

What are the limitations of the Buffett Indicator?

The stock market considers the value of all listed companies in India. However, Gross Domestic Product considers the value of all income, including unlisted private firms, MSMEs, small businesses, government companies etc. Hence, Buffett Indicator is unreliable as it only looks at listed companies when determining total stock capitalisation. 

• The Buffett Indicator is impacted by the trends in IPOs (Initial Public Offerings). 
• If there is a massive jump in publicly traded companies vs private companies, then the Buffett Indicator sees a jump even though nothing changes from the valuation perspective. 
• The Buffett Indicator suits developed economies such as the US, UK, France, etc., where business is biased towards the formal sector. However, it’s not an accurate indicator for developing countries like India, where the informal sector dominates industries. 

Market Capitalisation vs Free Float Market Capitalisation

The total market capitalisation of a firm includes publicly traded shares and shares held by the government, promoters and private entities. However, free-float market capitalisation excludes shares held by the government, promoters, trusts and private entities. 

For instance, to calculate free-float market capitalisation, you must multiply the current share price with the total outstanding shares traded with the public. 

• Total market capitalisation exceeds free-float market capitalisation as it includes shares held by the government, promoters etc.
• Stocks with a lower free-float market capitalisation are more volatile than those with a higher free-float market capitalisation.
• It is because the number of people trading in stocks of companies with higher free-float market capitalisation is high, which maintains price stability. 
• The BSE and NSE use a free-float market capitalisation approach to determine Sensex and Nifty, their benchmark indices and assign weightage to stocks in the index. 

Conclusion:

• Market capitalisation refers to a company’s worth determined by the stock market. 
• Investors can use market capitalisation to pick stocks based on their risk tolerance.