Market cap is an abbreviation of market capitalization. The term refers to the value or capitalization the market puts on a company. It is calculated by multiplying the price of the stock by the number of stocks issued. For example, if the stock of company XYZ is selling for $25 US dollars (USD) and there are 1,000,000 stock shares issued by XYZ, then the market cap for XYZ is $25,000,000 USD. Since the stock price typically varies from day to day, the value for a particular company also varies from day to day.
Market capitalization is only one of many ways to value a company. Another common method used to value a company is the book value. The book value is calculated as the difference of a company's assets and its liabilities. If company XYZ has $30,000,000 USD worth of assets — buildings, inventory, and so on — and $15,000,000 USD in liabilities — mortgages, loans outstanding, accounts payable, and so on — then the book value of XYZ is $15,000,000 USD.
The book value is also referred to as the net worth of the company. The market cap of a company and the book value of a company are almost never the same value. A high growth company typically has a much higher market cap than book value, while an established company with little growth expectations usually has one that is closer to the book value.
It is important to realize that both values are really just opinions. Market cap is the consensus opinion of what the market thinks the company is worth. Book value is based on what accountants think the assets and liabilities are worth. There are many rules and principles that accountants use to base these opinions on, but at some point someone makes a judgment call as to what a building is worth, or what the amount of inventory is worth.
It is disagreements with these opinions, in part, that give rise to the market. If someone thinks the market value is too high with respect to the book value, they will try to sell the stock. If they think it is too low, then they will try to buy stock in the company.
Finally, market cap is used to compare companies based on size. If PRQ company has a stock price of $40 USD and 100,000 shares outstanding, then its market cap is $4,000,000 USD. PRQ is a much smaller company than XYZ even though its stock price is much higher. It makes no sense to compare companies based on stock price alone, but it does make sense to compare companies based on the market valuation. Market cap is frequently broken down into the following ranks: mega cap, large cap, mid cap, small cap, micro cap, and finally nano cap — the largest to smallest.
