What is market-cap? – An introduction
Market capitalization is one of the most critical parameters that help an investor or a trader determine the risk profile and return estimates of a stock. It is used to decide what stocks to invest in, what diversification strategy to follow and to determine the market value of the company. All publically listed companies list their shares for trading on the stock exchange (majorly Sensex, i.e. Bombay Stock Exchange (BSE) and Nifty, i.e. The National Stock Exchange (NSE) in India) The actual outstanding value of shares of a company that are present for sale or a trade in the stock market is called market cap. The outstanding shares of a company consist of the shares which are held by private investors, institutional investors, employees of the company, among others.
The market cap is not the price of one share, but the face value of all the shares combined that are listed by the company.
Market Capitalization is usually the ‘Number of Outstanding Shares’ times the ‘Price of each Share’.
How to classify any market cap as large-cap, mid-cap or small-cap?
According to SEBI, i.e. the Securities Exchange Board of India, the first hundred, i.e. the top 100 companies in terms of the value of their market capitalization, are termed as large-cap companies. The primary example of large-cap companies in India are IT giants like Infosys, Tata Consultancy Services (TCS) and Wipro. Usually, these companies have a strong track record, are trustworthy and are known to generate good returns for the investors. One primary index for large-cap stocks is BSE-Sensex or BSE 100 (Bombay Stock Exchange 100). Market capitalization for the large-cap stocks in the BSE 100 Index usually ranges from ₹200 Billion to ₹3,500 Billion.
The next 150 companies, i.e. 101st to 250th ranked companies according to their outstanding market capitalization, are termed as mid-cap companies. Some examples of mid-cap companies in India are Godrej Industries Ltd & Dish TV India Ltd. and Tata Global Beverages Ltd. Usually, these companies are in their growth phase, and might soon move to the large-cap funds. These stocks typically have a market capitalization ranging anywhere between ₹50 Billion to ₹200 Billion.
All companies which are listed but ranked after the top 250 companies in terms of their outstanding market capitalization are termed as small-cap companies. These companies usually have a low capital base and fewer publically traded shares available in the market as compared to the other two segments. Startups and companies in their early stages of development when listed, usually come under the small-cap category. The primary examples of small-cap companies in India are Procter & Gamble Health Ltd., Spice Jet Ltd., and Ramco Systems Ltd. These companies are small to mid-level companies which are usually new entrants in the stock exchange market. These small-cap stocks are also called quick rich stocks or hazardous stocks, of which both of the labels are a misconception.
How to compare market caps of different companies?
E.g. A company ABC has one hundred thousand outstanding shares in the market that are currently being traded at a value of ₹ 25 per share, while at the same time, a company XYZ has five hundred thousand outstanding shares in the market that are currently being traded at a value of ₹ 10 per share, which company would have a higher market capitalization?
Calculating market capitalization of company ABC, the market capitalization would be one hundred thousand * ₹25, i.e. ₹ twenty-five hundred thousand, estimating the market capitalization of the company XYZ, its market capitalization would be five hundred thousand* ₹10, i.e. ₹ five hundred thousand.
Hence, the capitalization of company ABC is higher than the capitalization of company XYZ.
It is interesting to note here is that, since the companies are classified into large-cap, mid-cap and small-cap according to their rankings of the value of market capitalization amongst all the listed companies, any company can shift from one category to another, even if it’s market capitalization value has been constant. The growth or decline in market capitalization of all other companies that are listed on the stock exchange, also affects the classification of a company into large-cap, mid-cap or a small-cap firm.
When the number of a company’s outstanding shares increases due to the issuing of more shares by the company, then the market capitalization of the company also increases. Similarly, when a company buys back the shares, then the number of outstanding shares in the market decrease and the market capitalization of the company also decreases. The company can control its market capitalization to some extent by using buyback or issuing more shares, thus impacting & managing its ranking in both an upward and downward direction.
Large Cap Funds
Large-cap funds are majorly open-ended funds, in which most of the capital is invested in risk-free large-cap companies, which are expected to provide a high level of return to the investors. Usually, over 85 per cent of the funds are invested in large-cap companies. This factor makes these funds relatively the least-riskiest funds, which have excellent earning potential. These large-cap funds are usually recommended for investors who like to play it safe, would be happy to get a fixed return without any risk, even if the return is a bit less than the optimum value. These investors are usually in for the long haul. Aggressive investors typically stay away from this domain due to the dullness and mundanity of the market. Here the fund managers, usually have a limited role, except for monitoring the funds periodically. All the information is readily available in the public domain and can be easily accessed by anyone. So, selection of the right stock is the essential element here. The selected stock needs to be robust enough, that it can yield a specific interest percentage year on year with minimal risk of losing the investment.
Mid Cap Funds
Mid-cap funds are usually those open-ended funds, which balance the risk and return at an optimal level. Their majority investment is in companies having excellent growth potential and which have chances of making it to the large caps bracket soon. Since over 65 per cent of the investment is present in the equity and equity-related instruments of the mid-cap firms, this segment caters to people interested in higher growth opportunities but limited risk. Here, the fund manager needs to focus on selecting the right kind of growth opportunities and ensuring that the risk profile is maintained. Since the information is usually not available online, the fund manager needs to do proper research on the stocks he or she is investing in. Since the mid-gap segment is a bit bigger than the large-cap segment, the fund manager needs to put considerable effort into identifying the right opportunities in the section, which are growing towards the large-cap segment in the near future.
These companies are usually related to high risk and high gain. So, these funds are suitable only for those who can afford or want to take higher chances to get a better profit. Small-cap open-ended funds have over 65 per cent of their portfolio in equity and equity-related instruments of small-cap firms, which are usually new entrants in their filed and have recently listed on the stock exchange for trading. Passive investors or risk-averse investors typically stay away from this domain, as they do not often like the volatility of the market. The fund managers who manage small-cap funds, need to be very active and vigilant is this is a very volatile domain. The fund manager needs to maintain a constant vigil at the conditions in the market, as these stocks rise and fall within a timespan of a few days only. Here, opportunities that can give very high potential growth in the future are usually selected, and the risk factor is generally compromised while choosing the stocks for the fund.
Which types of funds are the best to invest?
The best type of funds to invest are the ones that match your needs, i.e. which can yield your desired return on investment at the least possible risk profile. For an aggressive investor, small-cap funds might be the lucrative option, while for an investor who is in for the long term, large-cap funds might be the best and the safest way to go forward with. So, while not every type of fund is suitable for every kind of investor, the nature of every sort of investor is appropriate for some particular type of funds for investment.