What is Market Capitalization?
Market capitalization is the total market value of a company’s outstanding shares. It is calculated as the total number of outstanding shares multiplied by the current share price. Market capitalization is also known as equity value and represents the value attributable to owners and shareholders.
Market Capitalization = Current share price x Diluted number of shares
Diluted shares include the effect of contracts or products the company has issued which could result in new shares being issued in the future.
Key Learning Points
- Market capitalization is calculated as the current share price multiplied by the diluted number of shares and is the total market value of a company’s outstanding shares
- Always use the diluted number of shares outstanding as the share price factors in the potential of any dilution in the future
- Diluted number of shares is the number of shares as if all dilutive contracts were exercised
- Only shares that are part of the company’s ordinary equity are included in the calculation
Calculating the Number of Outstanding Shares
The current share price can be easily sourced for any public company, however, calculating the number of shares can be trickier, so let us understand how to work out this number.
Basic vs. Diluted
The first step is understanding which number of shares figure should be used. Basic shares outstanding are simply the total number of shares available for trading in the stock market. If you are looking at an American company, you can find this information on the front page of their latest quarterly report (form 10-Q) or annual report (form 10-K) If it is not available, it can be calculated as the total number of shares issued by a company less any treasury stock.
Here is a snapshot from the Form 10-Q of Alphabet, Inc. for Q1 2020. On the front page, we find the total number of shares outstanding under each class.
Alphabet Inc – Extract from 10Q report 2020
The diluted number of shares outstanding is always used to calculate market capitalization. Diluted shares outstanding is the basic shares outstanding plus any net new shares added as if all dilutive contracts were exercised. Examples of dilutive contracts include stock convertible securities and restricted stock units (not to be confused with restricted shares).
To help understand why diluted rather than basic shares outstanding is used, consider the following question: if the number of shares increases in the future due to the dilutive contracts being exercised then might the traded share price fall? The answer is no. The traded share price already reflects dilution. The information about any possible dilution in the future is available publicly now and is already priced into the market value of the shares.
Types of Shares to be Included
It is common for companies to have such as class A or class B shares. If both classes of shares have the same economic value, you should add the number of shares in each class and multiply the total with the share price. If both classes have different economic values, you should arrive at the individual total value for each class and then add them together to get the total market capitalization.
In October 2020, Alphabet’s class A shares are trading at $1,439 per share, and class C shares were trading at $1,469. However, Class B shares are owned by insiders and do not trade on stock markets. To calculate Alphabet Inc.’s market capitalization, you need to calculate the equity value of each share class (price x number of shares) and then add them together.
For pricing the class B shares of Alphabet, Inc., different analysts may use different methods. The c Therefore, some analysts use the class A share price to calculate the equity value of class B shares. Another analyst may price class B shares as class A plus the difference between class A and C. Differences in valuing class B shares will lead to somewhat different market capitalization figures for the same company.
Excluding Preference Shares and ADRs/GDRs
If the company has preference shares, these should be excluded because they are not a part of a business’s ordinary equity. Likewise, if a company has issued American Depository Receipts (ADRs) or Global Depository Receipts (GDRs,) they should be excluded as well since these are copies of real shares and are already included in the number of shares outstanding.
Finally, restricted shares are never included in the count. These are shares that are already included in the number of outstanding shares. They are owned by shareholders already but have restrictions placed on them e.g. stopping them from being traded for a year.
Let us understand calculating market capitalization using the information below:
The table above lists information about a company. The two relevant figures relevant for the calculation is the share price for common shares and the diluted shares outstanding.
Market Capitalization = Current share price x Diluted shares outstanding
= 9.00 x 1,026,430
Why do we ignore the other items? The preferred shares outstanding are not included as they are not part of the company’s ordinary equity capital. Weighted average shares outstanding reflect the changes in outstanding shares across an entire earnings period. For valuation purposes, we are only interested in the number of outstanding at the valuation date. We therefore ignore this. Diluted shares outstanding are the most recent number of shares outstanding and thus the most relevant for market capitalization.
In this example, the company has two share classes. Both trade at the same share price. The market capitalization is calculated as:
= 4 x (962,540+53,600)
As mentioned above, the ADRs are excluded and can be ignored.