How are the share price and market capitalization of a company determined?
The total market value of a company is called its "market capitalization". The market capitalization of a company can be determined by multiplying the company's share price by the number of shares outstanding.
The share price is the relative and proportional value of the company. Therefore, it represents only the percentage change in the company's market capitalization at any given time.
Any percentage change in the share price will result in the same percentage change in the company's market capitalization. This is one of the main reasons why investors are so concerned about stock prices.
How is the share price determined?
Stock market prices are determined by supply and demand. This makes the stock market similar to other economic markets. When a stock is sold, the buyer and seller exchange money to own the stock. The price at which the shares are purchased becomes the new market price. When the second share is sold, that price becomes the newest market price, etc.
There are certain quantitative methods and formulas that can be used to predict the price of a company's stock. Called dividend discount models (DDM), they are based on the concept that the current price of a share is equal to the sum of all its future dividend payments (discounted to their present value). Dividend discounting models use time value of money (TVM) theory to determine a company's share of expected future dividends.
The market capitalization of a company is first established in an event called an initial public offering (ipo). In this process, the company pays a third party (usually an investment bank) to use very complex formulas and valuation methods to determine the value of the company. They also determine how many shares will be offered to the public and at what price. For example, a company valued at RUB 100 million may want to issue 10 million shares at RUB 10 per share.
After a company goes public and its shares begin to trade on the stock exchange, the price of its shares is determined by the supply and demand for its shares on the market. If, due to favorable factors, there is a high demand for its shares, the price will rise. If the future growth potential of the company does not look optimistic, sellers of the stock may reduce its price.
Misconceptions about market capitalization
Although the term is often used to describe a company (for example, large cap versus small cap), market cap does not measure a company's cost of capital. This can only be done by a thorough analysis of the company's fundamental indicators. Market capitalization is an inadequate way of valuing a company because the market price based on it does not necessarily reflect how much a piece of business is worth. Stocks are often overvalued or undervalued by the market; the market price only determines how much the market is willing to pay for its shares (not how much they actually cost).
The market cap of a company, also called “market cap”, is a measure of the market value of a company.
Market capitalization is calculated by multiplying the current share price by the number of shares outstanding.
For example, a company with 50 million shares and a share price of 100 rubles per share would have a market capitalization of 5 rubles.
Shares are often classified according to their respective market value of a company: “large caps” refer to a company with a high market value, and “small caps” refer to a company with a low market value.