In this article, you’re going to learn what is an index and what role does market capitalization play in buying or selling of stocks or in mutual funds. I’ve also added an example for you to understand what role does Market Capitalization play to decide whether a company is valuable or not.
So the Index is something using which the performance of the stock market is measured.
You might have heard people often say –
“Mann! Did you check the market today? It is underperforming today.”
or something like “Hey! Today the market was up!”
The market has been down by 10% the previous week
The question is what do they mean by that, are they talking about a particular stock? If yes then how can they say that the market is underperforming? Shouldn’t it be “this stock is underperforming”?
Well this is where the concept of index kicks in.
The index tells you about the performance of the market. How?
So instead of mapping the performance of a single stock, a group of stocks are selected using particular criteria. You can find more details on the eligibility criteria of these companies to get listed in a particular index by doing a simple search on the internet.
The index is updated with these stocks after a specific time period. So for example, the NIFTY index gets updated every 6 months.
If all of the stocks in that criteria are performing well, then obviously the index would be in green, and you may hear the people say, that the market is up.
In India, we have two indexes. NIFTY and SENSEX. So Nifty is an index which contains stocks listed in NSE whereas SENSEX maps the performance of stocks listed in BSE.
Similarly, in the US we have NASDAQ, Dow jones, s&P 500 and so on.
So this was all about indexes. Let’s now talk about market capitalization.
You may have heard of these terms –
Large cap, mid cap and small cap.
What do they mean, and what is their importance?
Let’s first start by understanding what market capitalization is.
The market cap of a company is simply the number of outstanding shares multiplied by the share price.
An example can be –
You might have seen that company X’s share price is greater than company Y’s share price. Does this mean the X is more valuable than Y. Not necessarily.
Why, the market capitalisation of Y might be more than X.
Hence let’s say if x has 10 outstanding shares and the price of 1 share is rs 10.
The market cap is 10 * 10 = 100
Whereas company B has 100 outstanding shares, and the share price of 1 share is Rs 5.
Total market cap is 100 * 5 = 500
So you can clearly tell now, which company is more valuable. In the above case, company B is more valuable than A.
I hope this article brings you some clarity on what is an Index and what is Market Capitalization.
If you haven’t already, checkout our previous article on a mind hack that can help you make millions!