What is Market Capitalization and why is it important ?
What is Market Capitalization ?
Market Capitalization, or Market Cap, is a term used to represent the market value of a company based on its current share price and the total number of its outstanding shares. It is one of the most important characteristics of a company and is useful for prospective investors in understanding the risks of investing in stocks of the company.
How to Calculate Market Cap ?
Market capitalization can be calculated by multiplying the number of outstanding shares of a company by the current price of its shares. For example, if a company issues one million shares at INR 100 each, its market capitalization is INR 100 million (1 million shares multiplied by INR 100).
On the basis of market cap, companies may be classified as large-cap, mid-cap or small-cap companies. These are described in greater detail below.
Large Cap :
Large cap companies are usually stable, reputable and well-established businesses that have a significant market share. They have market caps of INR 10,000 crore or more. Due to the low volatility in comparison with mid-cap and small-cap stocks, the risk associated with investing in the stocks of large-cap companies is very low. However, the downside to this is that the growth potential of these stocks is also low.
Mid Cap :
Mid-cap companies have a market cap ranging from INR 2,000 crore to INR 10,000 crore. While the risk of investing in these companies is higher than investing in large-cap companies owing to the increased volatility of their stocks, they tend to have a higher growth potential.
Small Cap :
Small-cap companies operate at a smaller scale than large-cap and mid-cap companies. Consequently, their market cap is also lower (less than INR 2,000 crore). Stocks belonging to these companies have considerable growth potential, but are also extremely volatile. Thus, they are often the riskiest options for investors.
Why market capitalization is an important concept
Market capitalization is important because it allows potential investors to understand the true value of companies and the size of one company in relation to another. It helps investors to predict the future performance of the stock of a company because it reflects what the market is willing to pay for the stock.
With the knowledge of the market caps of various companies, investors are able to make better informed decisions about the types of stocks they would want in their portfolios, in accordance with their investment plans. Over a long enough period of time, large-cap, mid-cap, as well as small-cap stocks have the potential to lead the markets due to being differently affected by changes in the economy. It is for this reason that investors prefer to have a diverse portfolio consisting of a well balanced mix of these three types of stocks.
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