How to Use Market Capitalization to Evaluate a Stock

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Updated May 20, 2024
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Market capitalization is a useful figure to examine when trying to understand a company's structure and profitability, and a stock's value. Market capitalization can be used to determine a variety of key performance metrics, including price-to-earnings and price-to-free-cash flow. Read on to see how market cap is used to evaluate stocks.

Key Takeaways

  • Market capitalization is the total dollar value of all of a company's outstanding shares.
  • Market cap is determined by multiplying the company's stock price by its total number of outstanding shares.
  • This figure can help investors assess a stock's value before they buy it.
  • Market capitalization is a key profitability measure that is also used in equations to determine P/E and other significant metrics.
  • Market cap is generally broken down as micro-cap, small-cap, mid-cap, large-cap, and ultra or mega-cap.

What Is Market Capitalization?

Market capitalization refers to the total dollar market value of a company's outstanding shares. It is thus calculated by multiplying the total number of a company's shares by the current market price of one share. The investment community uses this figure to determine a company's size, and basically how the stock market is valuing the company.

Company market caps are useful in categorizing stocks based on their absolute size, such as large cap versus small-cap stocks. It is also used as an input in various financial ratios and other metrics. We outline some of the key metrics where market cap is used below.

$3.16 trillion

The market cap for Microsoft (MSFT), as of May 20, 2024. This is the largest market cap of any company in the world. Apple (AAPL) and NVIDIA (NVDA) rounded out the top three companies by market cap at around $2.94 and $2.33, respectively.

Using Market Capitalization for Performance Metrics

There are popular valuation ratios that include market capitalization that investors should look at when considering buying a stock. These ratios include:

How to Calculate Notes
Price-to-Earnings (P/E) Ratio  Divide market cap by 12-month net income Can reference trailing earnings or projected future earnings 
Price-to-Free-Cash-Flow Ratio  Divide market cap by 12-month free cash flow Can also use historical or projected returns 
Price-to-Book (P/B) Value  Divide market cap by the company's total shareholder equity Can be used to identify undervalued companies
Enterprise-Value-to-EBITDA (earnings before interest, taxes, depreciation, and amortization)  Enterprise Value = Total of market value of common and preferred equity, minority interest, and net debt Similar to the P/E ratio. EBITDA measures operational returns in the short term. 

Note that free cash flow is derived by subtracting capital expenses from cash flow from operations.

It's important to remember that a company's market cap does not affect its stock price. Rather, its share price is used to calculate the market value of its outstanding shares.

Types of Market Capitalization

There is no official barrier for different categories of stocks based on size. But the following list generally refers to each category and their sizes:

  • Large (Big) Caps: These are companies with market caps over $10 billion
  • Mid Caps: Companies with market caps between $2 billion to $10 billion fall under this category
  • Small Caps: This category is made up of companies with market caps of $2 billion and under

There are other categories that investors will sometimes consider. For instance, small caps also include what are called micro caps, referring to small-cap stocks that are under $250 million, and ultra or mega-cap stocks, which are large caps that are over $50 billion.

Market capitalization is used to set investor expectations and shape investment strategy. Different types of investment strategies focus on the various market cap groups, and different valuation methods are applied depending on company size. Very large market caps are usually associated with mature, low-growth companies that pay dividends. Small caps are often growth companies with higher-risk profiles and generally do not pay dividends.

Large-cap stocks generally experience slower growth and are more likely to pay dividends than faster-growing, small- or mid-cap stocks.

Why Are Stocks Measured by Market Capitalization?

Market cap is a useful measure of a company's overall value, as the market sees it. Because different corporations have different amounts of shares available for trading, the market cap produces an apples-to-apples comparison regardless of the actual price of a company's stock.

Market cap is used to categorize stocks since certain investors look for attributes that accompany companies of different sizes. For instance, large caps tend to be more mature and stable companies that have already experienced a great deal of growth and that capture a large market share. Small caps, on the other hand, tend to be more volatile but may also be potential growth opportunities.

It is best to compare stocks of like market cap to one another. For instance, a small-cap growth stock should not be compared with a large-cap value stock.

How Does Market Cap Affect Stock Price?

Market cap does not influence share prices. It works the other way around. Market cap is arrived at by multiplying the share price by the number of shares outstanding. So when a stock's price rises, so too does its market cap.

Is There Such a Thing As a Good Market Cap for a Stock?

This is all a matter of perspective. Sometimes small-cap stocks outperform larger stocks, but they also tend to be riskier or more volatile investments. Once a company grows very large, it may no longer be as nimble or able to take advantage of new growth opportunities. At the same time, large caps tend to be stable investments and may be more likely to pay dividends to shareholders.

The Bottom Line

A company's market capitalization is the total value of its outstanding shares. It can be used to evaluate a company's stock performance, such as the P/E ratio or P/B value. As an investor, you should keep an eye on any company's market cap, as it can tell you whether it is a good investment, how risky it is, and how your investment may perform over time.

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  1. Companies Market Cap. "Companies Market Cap."

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