In recent years there has been a huge influx of new investors in the stock market and the mutual fund market. Indian investors have realized the potential of equity markets and the need of investing in such markets to maximize their wealth in the long run. While understanding the investment in stock markets or mutual fund markets, there are many concepts that need to be understood by the investors to ensure that they make an informed decision while creating their investment portfolio. One of such relevant concepts is market capitalization.
Given below are the details of the market capitalization and its importance.
What is market capitalization?
Market capitalization in the simplest terms is explained as the market value of the company which is derived based on specific factors. It helps the investors in knowing the worth or the valuation of the company which is one of the many factors influencing their investment decision. The market capitalization of a company should not be considered as the sole factor in making an investment decision as it is a general indicator of the position of the company in the particular industry.
What is the importance of market capitalization?
While investing in the stock markets, it is often a difficult choice for the investors to choose between the two or more potential investments, especially for novice investors. Most investors get easily influenced by the size of the company and think that the bigger the size, the better the company. This might be true in some cases but cannot be taken as a general rule of thumb.
Market capitalization has a standardized or uniform mode of calculation which helps the investors navigate through multiple investment options and choose an investment that can fit their investment strategy as well as helps them diversify their portfolios.
How can an investor calculate market capitalization?
Market capitalization provides information about the valuation of the company. The factors used for the calculation of the market capitalization of the company are the price per share of the company and the outstanding number of shares of the company.
The mathematical formula for calculating the market capitalization of the company is given below.
Market Capitalization = Market Price of the share (P) x Number of outstanding shares (N)
In the above formula, the market price of the shares is the current market price or the closing market price as the case may be.
For example, if the current market price of the shares of Company A is Rs. 1,000 and the number of outstanding shares of the company is 1,00,000, then the market capitalization of Company A is calculated as under.
Market capitalization Company A = Rs. 1,000 * 1,00,000
Market Capitalization = Rs. 10,00,00,000
How are equity stocks classified based on market capitalization?
Market capitalization is one of the many parameters that are used to classify equity stocks. Equity stocks are broadly classified into three categories as per market capitalization. The details of the same are given below.
a. Large cap stocks
Large-cap stocks as the name suggests are the companies with the highest market capitalization. These stocks are the giants in their sectors or industries. As per SEBI, companies having a market capitalization of Rs. 20,000 crore or more are classified as large-cap stocks. These stocks have the least risk and the returns are more or less consistent. Indian companies like Reliance Industries, TCS, SBI, etc. are considered to be large cap stocks.
b. Mid-cap stocks
Mid-cap stocks are mid-level stocks with market capitalization lower than the large-cap stocks but higher than small-cap stocks. As per SEBI, companies having a market capitalization of Rs. 5,000 crores and Rs. 20,000 crores are classified as mid-cap stocks. These stocks have relatively higher risks than large-cap stocks and the returns are also slightly higher on account of the added risk. Mid-cap stocks have huge growth potential and an average investment horizon of 3-5 years to generate decent returns for the investors. There are many companies that fall under this category like Crompton Greaves Consumer Electricals, Relaxo, Polycab, etc.
c. Small-cap stocks
This is the last category of equity stock classification based on market capitalization. Small-cap stocks are the companies with the lowest market capitalization among their peers. SEBI provides that any company having a market capitalization of less than Rs. 5,000 crores, to be classified as small-cap stocks. The risk of loss is highest in the case of these companies with the potential to provide the highest returns in a bullish market. Some examples of popular small-cap stocks are Thyrocare Technologies Ltd., Delta Corp Ltd., etc.
What is free-float market capitalization?
Free float market capitalization is another important concept to be understood by investors to make better investment decisions. The total number of shares of the company also includes the promotor’s stocks which are in reality not available for trading or making the ordinary shareholders or investors. The actual number of shares available in the market for trading is known as float.
Free-float market capitalization enables the valuation of the company based on the actual number of stocks in circulation in the market and not held by promotor or other important personnel of the company, i.e, stocks that are not in rotation in the market. This gives the true position of the company and its true market capitalization.
How equity mutual funds are classified based on market capitalization?
Market capitalization can also be used to classify mutual funds. Following are the basic classification of mutual funds based on market capitalization.
Large cap mutual funds are the funds that invest majorly (65% – 80% of the fund) in large cap stocks. As per the specifications of SEBI, these companies rank among the top 100 companies (1st to 100th) based on market capitalization. These funds are relatively less volatile and provide more or less consistent returns.
Mid cap funds are the mutual funds that invest a minimum of 65% of the fund in mid cap stocks and the balance investment can be in the debt or cash segment. According to SEBI, these companies rank from 101-250th in terms of market capitalization. These funds provide higher returns as compared to large cap funds but the risk is also relatively higher. These funds are ideal for moderately aggressive investors looking for higher returns at calculated risks.
Small cap funds are mutual funds that invest predominantly (65% or more) in small cap equities. The balance of the fund can be in the large cap or mid cap segment as well as debt or cash segment to balance the risk. As per SEBI guidelines, the small cap companies are those ranking 251st and above in terms of market capitalization. These funds have the potential to provide maximum returns than any equity-oriented funds in the bullish market but the volatility of these funds is quite high. These funds are best suited for aggressive investors that have a high-risk appetite to match the high returns expectations.
d. Multi cap equity funds
Multi cap funds are the funds that invest in all categories of equities whether they are large cap, mid cap, or small cap. As per the revised rules of SEBI, these funds require a minimum investment of 75% in equity and equity-related instruments. Moreover, the fund requires a minimum of 25% investment in each of the three categories of equity funds (25% large cap stocks, 25% mid cap stocks, and 25% small cap stocks). The fund is created based on the expertise of the fund managers and their investment strategy to meet the investment goals of the fund.
Market capitalization is often used when discussing stocks and mutual funds. This is an important parameter that allows the investors to choose their investments prudently and after careful analysis of their risk parameters as well as returns expectations. It is a good indicator of the financial position of the company but investors have to be cautious while making their investment decisions and not solely rely on the market capitalization of a company.
1. How are the large cap, mid cap, and small cap funds taxed?
A. The tax treatment for equity funds is the same irrespective of them being large cap, mid cap, and small cap stocks or funds. The details of the same are tabled below.
|Type of funds||Short term gains||Tax rate||Long term gains||Tax rate|
|Equity mutual funds||Less than 12 months||15% (plus cess and surcharge)||12 months and more||Exempt up to Rs.1,00,000Above Rs.1,00,000 taxed at 10% (plus cess and surcharge)|
2. What are the ideal equity stocks or funds for risk averse investors?
A. for risk-averse investors, large cap stocks or funds are ideal as they have the least amount of risk involved as well as provide more or less regular returns to the investors.
3. Is market capitalization the most crucial factor in making an investment decision?
A. No. The market capitalization of the company is simply the indication of the position of the company in the market and its respective industry. It cannot be taken as the sole consideration or the most crucial consideration while making an investment decision.
4. How can a person have a balanced equity portfolio?
A. To have a balanced equity portfolio, investors can invest in multi cap funds or equities from each category of market capitalization (large cap, mid cap, and small cap) in a set proportion. Such proportion can be based on their risk profile and returns expectations as well as investment goals and period of investment.