The term market capitalization refers to the hypothetical value of a company based on its total shares. Market capitalization is found by multiplying total shares by the going share price.
Example: A company's shares are trading at 150 Swiss francs. The company’s entire stock is made up of 1 million shares. So the company’s market capitalization is 150 million francs (1 million x CHF 150). If the price of the company's shares slid to 149 francs per shares, then its market capitalization would be 149 million (1 million x CHF 149).
Market capitalization indicates a company’s market value. However, market capitalization rarely provides a clear indication of the true value of a company because there are many factors which affect share prices. For example, media hype may lead to a surge of investment and a resulting spike in a security’s market price. In that case, the market capitalization of that security may be much higher than its true value, and it is likely that the value of the security will decline in the future.
Book value, which indicates the accounted value of a company’s capital, can be a more realistic indicator of a company’s value – particularly for company’s which primarily require physical capital to conduct their business.
Because market capitalization is driven by demand for a stock rather than production or revenue, it is also possible for company’s to be undervalued. For example, demand for a company’s stock may be low due to lack of knowledge or interest on the part of investors, but its production, growth potential and revenues may be high.
When contemplating investing in a stock long-term, factors like growth potential, productivity, management and revenues should be considered in addition to market capitalization.
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