What is Market Capitalization?
Market Capitalization, or “market cap”, represents the total value of a company’s common shares outstanding to its equity holders. Often used interchangeably with the term “equity value”, a company’s market capitalization measures the value of its common equity as of the latest market close.
How to Calculate Market Capitalization (Step-by-Step)
Market capitalization, or “market cap” for short, is defined as the total value of a company’s equity and is typically used when discussing the valuation of public companies.
Otherwise, if the company is private – i.e. if its shares of ownership are not publicly traded on the stock markets – the value of its equity should be referred to as equity value, instead.
When equity analysts and investors discuss the value of companies, two of the most frequently used terms are “equity value” and “enterprise value”, which are briefly explained below:
- Equity Value (Market Capitalization): The value of the company to the owners of its common equity (i.e. the common shareholders)
- Enterprise Value: The value of the operations of the company to all stakeholders – or, said differently, the value of a company’s operating assets minus its operating liabilities
Enterprise Value vs. Equity Value Illustration
Market Capitalization Formula
To calculate the market capitalization of a company, you must multiply the company’s latest closing share price by its total number of diluted shares outstanding, as shown below:
The common share count used in the calculation must be on a fully diluted basis, which means the potential net dilution of options, warrants, and other mezzanine financing instruments like convertible debt and preferred equity securities should be incorporated.
If not, there is the risk that the market capitalization calculated is lower than it actually is, as there would be share issuances left unaccounted for.
Equity Value vs. Enterprise Value: What is the Difference?
- Enterprise Value (TEV): The enterprise value is the value of the operations of a company to all capital providers with claims, such as common shareholders, preferred shareholders, and lenders of debt.
- Equity Value: On the other hand, equity value represents the residual value left to only equity holders. While enterprise value is considered to be capital structure neutral and unaffected by financing decisions, equity value is directly affected by financing decisions. Therefore, enterprise value is independent of the capital structure, unlike equity value.
Market Cap Categories (Levels): FINRA Guidance Chart
Equity analysts and investors following the public equities market will frequently describe companies as “large-cap”, “mid-cap” or “small-cap”.
The categories are based on the size of the company in question and which group it falls under given the following criteria per guidance from FINRA:
Calculating Market Cap from Enterprise Value
Under an alternative approach, we can calculate the market cap by subtracting net debt from the enterprise value of the company.
For privately held companies, this particular approach is the only viable method to compute the equity value, as these companies do not have a readily available public share price.
To get from the enterprise value of a company to its equity value, you must first subtract net debt, which can be calculated in two steps:
- Total Debt: Gross debt and interest-bearing claims (e.g. preferred stock, non-controlling interests)
- (–) Cash & Cash Equivalents: Cash and cash-like, non-operating assets (e.g. marketable securities, short-term investments)
In effect, the formula is isolating the value of the company belonging solely to common equity shareholders, which should exclude debt lenders, as well as preferred equity holders.
While the treatment of these securities can be specific to the firm or individual, if an option tranche is “in-the-money” (i.e. there is an economic incentive to execute the options), the option or related security is assumed to be executed.
However, in recent years, the industry norm has shifted towards more conservatism by taking into account all potentially dilutive securities issued, no matter if they are currently in or out of the money.
The proceeds received by the issuer as a result of the exercise are then assumed to be used to repurchase shares at the current share price, which is done to minimize the net dilutive impact.