Finnovationz - December-21-2018
Let's start this topic with a small exercise:
Suppose, there are two companies X & Y. The price of one share of company X is Rs. 50 & price of one share of company Y is Rs. 150. Can you tell me which is the bigger one? Is it company Y? no.
Why? let me tell you, you cannot figure out the size of the company just by looking at the price of the share of the company. To find out the size of the company you need to calculate market capitalisation of the company. Market capitalisation is the measure of the size of the company.
Market Capitalisation= Price of one share x Number of outstanding shares
The number of shares that are held by investors (including employees and executives of the corporation) are known as outstanding shares. You will get outstanding shares in Balance Sheet of the company. Nowadays Market capitalisation of any company is readily available on website of economic times & moneycontrol.com
Let's assume, total outstanding shares of company X are 1 crore & that of Y are 30 lakhs.
Hence, Market capitalisation of company X= 50 x 10000000 = 50 crore
& Market capitalisation of company Y = 150 x 30,00,000 = 45 crore
Hence, company X is bigger than company Y, in spite of the lower price. Their share prices tell you nothing by themselves. When a company's share price goes up or down, the market capitalisation will increase or decrease. Market capitalisation is the aggregate valuation of the company. It will tell you the cost to buy the company in the open market.
When understanding how to allocate funds for investing in equities, it is important to understand both your expectation of return i.e, your financial goals and also your risk appetite. By knowing the market capitalisation of a company you can find out the risk & reward factors. In diversification of portfolio, market capitalisation plays an important role, as company size is one of the criteria in the diversification of portfolio.
Basically, there are three types of companies:
1) Small cap
2) Mid cap
3) Large cap
Here, cap stands for Market Capitalisation.
Companies with a market cap of Rs 65,000 crore or more are known as large cap companies. Companies with a market cap between Rs 13000 crore and 65000 crores are mid-cap companies and those less than Rs 13000 crore are small cap companies. Different numbers are used by different countries. There is no official definition of the exact cutoff values. The definitions expressed need to be adjusted over decades due to inflation, population change, and overall market valuation. What is mid-cap today was large cap a decade ago.
1) Small Cap:
Small Cap companies are usually small companies, start-ups & many of which recently went through their Initial Public Offering or IPO. They have a market cap less than Rs. 13000 crores.
On the other hand, they have lots of room to grow, and could become very profitable. Such a company has a potential to grow fast and become a Mid Cap in the future. Small-cap companies pay little in the way of consistent dividends to investors. This is because they need to reinvest profit back into the company to grow. There is a greater chance of a small company going out of business than mid-cap or large-cap companies. They do not have strong financial backup hence more likely to affect during economic downturns & hence riskier than large cap & mid cap stocks.
2) Mid Cap:
A mid-cap company is seen as the middle of the road in terms of risk because there is less potential that they go out of business than in the case of small-cap companies. Mid cap companies are less risky, but may not have the same potential for growth as a small cap company. Mid caps range from Rs. 13000 crores to 65000 crores. These might not be industry leaders but may be on their way to becoming one.
3) Large Cap:
Large-cap companies, also known as blue chip companies, have the least risk because they typically have the financial resources to weather a downturn. Large caps are companies which have a market cap more than 65,000 crores rupees. Since they tend to be market leaders, they also have less room to grow. They have strong financial backup hence less likely to affect during economic downturns.
They are also more likely to pay dividends more consistently than small-cap & mid cap companies. Large-cap companies are usually seen as the safest investment for those looking to gain a stable return.