How does Market Cap affect Stock Prices?

Short Answer

Market capitalisation shortly called market cap is the company’s worth, its ranking and the relative size in an industry or sector. Market cap can affect stock prices, let's see how it is possible.

Detailed Answer

To know a company’s market cap, the stock price is multiplied by the number of outstanding shares that a company has.

As an example, if a company has $2 million outstanding shares and its market price is $10, the market cap is $20 million. Participants group these companies in different categories which are large-cap, mid-cap and small-cap.

How does the Market Cap affect Stock Prices?

Here are ways in which a company’s market cap can determine the stock prices:

1. Size of the company

The price of a stock can go up or down relative to financial market participants outlook of a company’s market cap. For instance, although small-cap does have a greater potential for growth with a higher return, they may be considered riskier because of their size, if there are fear and uncertainty in the future growth prospect of the company, it could drive the price down.

It’s one of the reasons why large market cap companies’ stock prices can increase significantly as they are considered a safer investment.

2. Law of supply and demand

The stock prices are also influenced by the law of demand and supply. If more investors are willing to buy a stock (demand) than sell it (supply), the price will go up. Conversely, higher availability and low demand will bring down the stock prices.

A company that produces goods with little to no competition and is highly desired and necessary will see the stock prices go up. A company that is experiencing less demand and fewer earnings will cause the stock price to go down. Buyers will be asking for discounts on the prices and sellers will be more than willing to sell in order to get rid of the stocks.

3. Diversification of portfolio

Market cap is one of the thing investors look into when it comes to the building of the portfolio. The different market caps are affected differently by economic and market conditions. large-cap, midcap, and small-cap stocks have varying risk levels and returns.

While large-caps are experiencing a decline, small or mid-caps might be booming and help compensate for the loss. Hence, a mix of these can help reduce investment risk.

4. Price

New and novice investors tend to make the mistake that the stock prices reflect a company’s worth and performances. Then think higher stock prices portray the company’s stability and the earnings potential.

This is not always the case and stock prices alone cannot give a complete picture of a company worth. The market cap gives a clearer insight into a company’s equity worth and the value it holds in the market. Knowing this will help you know a company’s size, the return potential and risk level.

Market Cap Influences Stock Prices

Market cap has a great influence on stock prices as it shows if a company is worth investing in which ultimately can drive the stock prices up or down.

What do you think about significance of market cap of a company? Do comment and share your views.

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