The total value of an asset when taking the number of units available and multiplying it by the present price.
- Cryptocurrencies - total tokens or coins issued x price.
- Equities - total number of shares outstanding x price.
Many feel that market cap is one of the best ways to determine overall value. For larger floated assets, this could hold some merit. However, for those assets that have lower distribution and are very volatile, the fluctuations could make analysis very difficult.
Stocks
The stock market tends to be broken down by market capitalization. This is where we get the concept of :
- Micro Cap : Less than $250M
- Small Cap: $250M - $2B
- Mid Cap: $2B - $10B
- Large Cap: $10B - $220B
- Mega Cap: $200B or greater
Here we are dealing with public companies that have freely floating share prices. Private equity deals and non-public firms do not fit into this model.
The market cap for stocks is based upon the total number of outstanding shares that shareholders have in their possession. This differs from the market cap for the company which includes the value of the public bonds outstanding.
Market capitalization is important for categorizing companies based upon size. However, investors need not to fall victim to some assumptions.
Large or mega cap stocks do not necessarily have a greater return than small cap. These are based upon the business practices of each individual company, the appetite for risk of the market at a particular time, plus the revenues and earnings of the individual corporations.
Another fallacy is that small cap (or even micro-cap) stocks are start ups. Many long established companies fall in this range. They do not have a great deal of shares outstanding and might be in businesses that do not warrant a large market cap. For example, there might be a company that operates regionally, meaning it is going to be smaller than national competitors.
We can take away a few things from market capitalization.
Large and mega cap stocks tend to be less inclined to be disrupted by economic conditions. They will also not be hit as badly in market selloffs. Volatility is also likely the affect smaller market cap stocks than the larger counterparts.
Dividends are also likely to be found in the large and mega cap end of the spectrum. Smaller companies might be focused more on growth. At the same time, they are cash constrained when compared to the overall size of the large counterparts.
Reinvestment of earnings is common in the smaller entities as the size prohibits sending capital out of the company.
Cryptocurrency
When cryptocurrency started to take off, many sites such as Coingecko started to rank the different coins based upon market capitalization. This was misleading since these assets do not represent the same thing as stocks.
For example, what is the market cap of the US dollar? Or the Japanese Yen? Most are unfamiliar with this simply because we do not think in these terms.
With the emergence of stablecoins, the industry went through a bit of a transformation. Now, coin that are tied to blockchains could be considered value capture tokens. What is occurring within that ecosystem might be seen in the price action by the market. This drew a distinction between the different types of coins.
When dealing with newer entities, it is also misleading to attach value based upon market activity. There are many instances where market caps skyrocketed simply because a pump and dump was taking place. It is easy to see this after the fact but many people got caught up in the FOMO.
In the end, within cryptocurrency, market cap tells us even less than stocks. There are no dividends to be had so this is not relevant.
The flippening is a debate within cryptocurrency as to whether the market cap of Ethereum would flip that of Bitcoin. The latter is the largest cryptocurrency by this metric. Ethereum has held the title of largest altcoin for a number of years.