by George Marron

Created on: May 26, 2008   Last Updated: March 29, 2012

Market cap is just a cool way that business people say market capitalization. Market capitalization is the value or capitalization the market puts on a company. It is calculated by multiplying the price of the stock by the number of stocks issued. If, for example, the stock of Company X sells for fifty dollars and there are one million stock shares issued by Company X, then its market cap is fifty million dollars ($50 x 1,000,000). One must be aware that the market cap will fluctuate on an ongoing basis. This volatility occurs because the price of a company's stock fluctuates throughout the day.

It is quite a consensus among the business community that market capitalization is what the market thinks the company is worth. Another way to use market cap is to look at the book value of a company. Book value is the net worth of the company. The book value is calculated as the difference between a company's assets and liabilities. If company X has total assets of sixty five million dollars and total liabilities worth thirty million dollars, then its book value is thirty five million dollars ($65,000,000 - $30,000,000). The assets of an organization are buildings, equipment, inventory, and cash, and among other things. Liabilities are composed of loans outstanding, accounts payable, mortgages, and so on. Book value of a company is the net worth of the organization.

Now that we have clear definitions of market cap and book value, we can apply both measures for the company's best interests. First of all, market cap and book value are hardly ever the same amount. A high growth organization has a higher market cap than book value whereas a company with little growth expectations will have a market cap closer to its book value. When the market capitalization value is relatively too high with respect to book value, then the consensus would be to sell the stock. Conversely, if the market cap is too low as compared to book value of a company, then it would be a good idea to purchase the company's stock.

Lastly, market cap is used to compare companies based on size. If Company Y has a stock price of sixty and one hundred thousand shares outstanding, then its market cap is six million dollars ($60 x 100,000). Company Y ($6,000,000) is smaller than Company X ($50,000,000) despite Company Y's stock price being much higher. So, it is a good idea to avoid comparing companies based solely on stock price. It is important to learn some of the basics of the stock market since many people own 401Ks. It is a handy tool to know and it could help you increase the value of your portfolio.

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