Analysts and investors use market capitalisation to categorise and compare company sizes. Companies are classified as large-cap, mid-cap, or small-cap, depending on market capitalisation.

What is market capitalisation?

Market capitalisation (Market Cap/MCAP) refers to the company’s total value based on its current stock price and outstanding shares. You can calculate the market capitalisation by multiplying a company’s current share price by the firm’s total number of outstanding shares.

According to SEBI, listed companies ranked from 1st to 100th, depending on market capitalisation, are considered large-cap, from 101st to 250th are called mid-cap, and from 251st onwards are called small-cap.

How do you 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.

Formulae: Market Capitalisation (MCAP) = CMP x Total Number of Outstanding

Let's understand the formulae with the help of some examples,

Example 1: 

If a company has three crore outstanding shares, and each share’s CMP is Rs 300, the company’s market capitalisation would be

3,00,00,000 x 300 = Rs 900 crore.

Example 2: 

If a company has two crore outstanding shares, and the CMP of each share is Rs 200. The company’s market capitalisation would be

2,00,00,000 x 200 = Rs 400 crore.

What are the different types of classifications in market capitalisation?

Large Cap:

Large-cap companies have a market capitalisation of Rs 20,000 crore or more. They are well-established companies with a significant market share.

Mid Cap:

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:

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.

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 the thumb rule, if the stock market capitalisation to GDP ratio is between 50% and 75%, stock markets are said to be modestly undervalued. Stock markets are valued if the ratio is between 75% and 90%. 

However, markets are said to be modestly overvalued if the ratio is between 90% and 115%.

The market capitalisation to GDP Ratio, the Buffett Indicator, shows the stock market valuation at any time.

If the Buffett Indicator is high, companies’ output is low compared to their stock market valuations.

Suppose the Buffett Indicator moves far ahead of its long-term averages; this signals a likely market correction as optimism levels among market participants are too high.

Market Capitalisation vs Free Float Market Capitalisation

A firm's total market capitalisation 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.

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, maintaining 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.

Example:

To calculate free-float market capitalisation, multiply the CMP/LTP by the total outstanding shares.

What are the limitations of the Buffett Indicator?

The stock market considers the value of all listed companies in India. However, Gross Domestic Product is the value of all income, including unlisted private firms, MSMEs, small businesses, government companies, etc. Hence, the Buffett Indicator is unreliable as it only considers 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 compared to private companies, then the Buffett Indicator will see 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.

Conclusion:

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

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