Total capitalization - is an assessment of the economic value of the company's shares admitted to official trading on the stock exchange. Total capitalization is calculated as the product of the number of shares issued and the market price of one share (Peterson P., Fabozzi F. 2013).
Fundamentals of total capitalization
This financial indicator is used to estimate the aggregate value of market instruments, entities and markets, in particular, there are:
- Capitalization of a security - is the market value of one issued security of a certain type. The most commonly used quote on the stock exchange;
- Capitalization of a joint - stock company is the estimated value of all shares of this joint-stock company. It is a product of the number of shares of a joint stock company at their current price;
- Capitalization of the stock market - is the total market value of securities traded on this market.
The form of capitalization has obvious similarities with subjective (marketing) capitalization. However, capitalization in this case is initiated not by internal management, but by external exchange structures that carry out stock quotes. The results of exchange trading, as you know, are formed under the influence of a set of objective and subjective factors, but the effect of subjective factors is minimized by public recognition ( Viale R., Etzkowitz H. 2010).
Grouping of companies based on total capitalization
The availability of information on the value of the company enables investors to group certain of the company together to produce a distributed investment. Among the groups are the following: companies with low, medium and high market capitalization.
Low-capitalization companies usually have a market value between five hundred million and two billion dollars, however, these values are not fixed. Companies with low market capitalization can provide good opportunities, because their shares are usually much cheaper than the rest. With the exception of periods of economic instability, companies with low capitalization can outperform larger companies due to higher growth potential. Trading shares of low-capitalization companies can be more difficult because their liquidity is lower than that of medium-and high-capitalization companies because fewer people trade them.
Medium-capitalization companies have the potential to grow through product development and consumer acquisition, while larger companies could already reach the limit of natural growth. In addition, they pay dividends more consistently than small companies. The potential of medium-sized companies is often easier to assess because their accounting and financial statements are much smaller and easier to read than those of large companies. Because of this, it is easier to decide on what new products the companies work, and what the forecasts are for their future. Medium capitalization companies have more ways to access substantial funding, so if developing a new product leads to a serious increase in revenue, the result could be a good profit for the trader who will buy the shares of this company.
High-capitalization companies are generally considered to be the safest investment for those who wish to make a stable profit, as they usually pay dividends on a more regular basis than low-or medium-capitalization companies. Large companies have access to more intensive financing and more funds, making them more resilient in volatile economic conditions. During economic downturns, a sharp increase in the number of investments in these companies is possible because of their safety. Large companies have the least potential for significant growth, as usually reached the maximum number of customers that can be purchased naturally ( Klaasen P., Eeghen I. 2009).
The main methods of valuation total capitalization
There are four main methods of assessing the company's capitalization: Split rate capitalization; Capitalization of earnings; Straight line capitalization; Direct overall capitalization.
1) Split rate capitalization – is a capitalization of a revenue stream that is not expected to change and is not limited in time; or capitalization of an asset that is expected to be sold at the same price as the purchase price, and therefore does not require a refund of capital. Two different interest or discount rates are used to estimate the projected cash flows for the same object.
2) Capitalization of earnings – is an assessment of the economic potential of the enterprise by calculating the present value of net profit, which is expected to be obtained in the future.
4) Direct overall capitalization – is the method is based on the division of net operating income by the coefficient obtained from the analysis of comparable objects and comparison of income from these objects with the prices of their sale.
It all depends on what the purpose of the valuation of the company. Different variants of discounted cash flow method are used to determine the price of the sold block of shares when attracting investments, selling a business (or a share in a business) to a third-party investor, acquiring a business or a share in it (The Office of Program Research 2015).
Distributed trading at different levels of capitalization
The allocation of responsibilities between companies with different capitalization can help prevent a situation in which it is too one-sided. Overuse of large companies will limit potential growth, while overuse of low companies can be too risky.
When you are going to trade or invest in stocks, it is a good idea not to be exposed to just one aspect of the market. Many traders and investors argue that it is worth keeping large companies for constant profit, but also leave room for small ones that have high growth potential and large possible profits (Damodaran A. 1998).
- Damodaran A. (1998), Finding the Right Financing Mix: The Capital Structure Decision, Stern School of Business, p. 157.
- Klaasen P., Eeghen I. (2009), Economic Capital, How it Works and What Every Manager Needs to Know, Elsevier, Burlington, p. 11-13.
- Min. K., Fai L., Yoong L. (2017), The Impact of Capital Structure and Agency Cost on Firm's Profitability of Industrial Product Sector, Bachelor of Business Administration (Hons) Banking and Finance, p. 1-11.
- Peterson P., Fabozzi F. (2013), Capital Budgeting: Theory and Practice, John Wiley & Sons, Inc., Canada, p. 3-7.
- Piketty T. (2014), Capital in the Twenty-First Century, The President and Fellows of Harvard College, London, Englend, p. 37-42.
- The Office of Program Research (2015), Washington State Capital Budget , Washington State Legislature, p. 9-21.
- Viale R., Etzkowitz H. (2010), The Capitalization of Knowledge, Edward Elgar Publishing, Massachussets, p. 31-33.
- Zhang L. (2013), The impact of ownership structure on capital structure, University of Twente, Netherlands, p. 4-5.
Author: Anna Korovytska