Thursday, April 9, 2009

What is market capitalisation?

There are two terms that define the value of the company.

1. The asset value
2, The market capitalisation

The asset value

The asset value is typically the total commercial value of all the buildings, equipment, furniture, patents , etc of the company. Typically everything that can be sold for a price. The reason that asset price is not used is that investors prefer to use market capitalisation as it is a better estimate of the company's ability to make a profit. A lot of asset is not an indication of the ability to make profit.

The market capitalisation

The market capitalisation can be calculated using a simple formula

Market capitalisation = share price X number of oustanding shares

Companies are classified in six broad categories depending on their market capitalisation.

Mega cap

A mega cap company is one that has a market capitalisation greater that $200 billion dollars. These companies are generally large and profitable such as Exxon. There are few of them. Generally their shares are quite expensive and difficult to obtain. If you have them in your portfolio keep hold of them.

Large cap

A large cap is a large company with a market capitalisation of $ 10 billion to $ 200 billion. Examples are Microsoft and IBM. These companies are relatively safe to invest but just as the mega cap their shares are relatively expensive and difficult to get. If you have them keep them unless a major catastrophe will befell the company.

Mega caps and large caps are also called blue chip companies. They are relatively secure to invest in. If you can get your hands on them in this bear market buy them and keep them. You will hold them for the long term.

Mid cap
A mid cap company has a market capitalisation of between $2 billion to $ 10 billion. However these companies offer greater return to the investor but a few of them will certainly fail. This make them a risky bet for the investor so it is better to limit your exposure to mid cap to not more that 20 %.

Small cap

A small cap company is relatively young and has a market capitalisation of between $ 300 million to $ 2 billion. Such a company offer great opportunity for growth. Imagine that if you invested in microsoft when it was a small cap you would be rich today. However a lot of small cap

Smaller companies are called micro caps and nano caps. They are very risky and if you want to invest in them you have to be very careful and limit your exposure to them to just a few percentage points of your wealth.

One last piece of information is that this information is not valid for every country. It is made for multinational companies. If you want to have your own classification for say Egypt, you will have to take the biggest company by market capitalisation and called it a mega cap and classify the other companies according to their market capitalisation.

Good luck. As usual i would like to give this advise again. As a new investor you should limit your exposure to small caps and mid caps. Only after having gained some experience and being able to analyse companies can you increase your exposure to them.

Happy investing.

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