It never occurred to some of us that one day, the term market capitalization, a stock market term used only among stockbrokers and investment bankers would become a common vocabulary.
Market capitalization (market cap) is a measure of the market value of a company or a business organisation. It is simply the number of shares issued by a company multiplied by the market price per share on the stock market.
When you want to know how big a company is, the fastest way to establish this is to look at the market capitalization.
Market capitalization is also used to determine the level of wealth of individual investors in listed companies.
It would have taken a long process to determine the worth of the likes of Bill Gates, who retired recently from his executive roles in Microsoft, a company he started from scratch, or the Mexican Tycoon telecom, Carlos Slim, the richest man in the world.
Indeed, it is said that Carlos Slim owns 50 per cent of the market capitalization of the Mexican Stock Exchange.
When the market cap of all companies listed on a stock exchange is added up what we get is the total market cap and this is used to determine the size of a stock market.
When comparing stock exchanges, it is the market cap that is used. Market cap is only applied in shares or equities markets and not debt market.
The common measure of size for debt market is the amount of outstanding debt or principal debt that has not matured.
The use of the market cap as the monetary value of a company is one of benefits of going public or listing a company on a stock market.
The key advantage of market capitalization as a measure of the value of a listed company is that the figure is easily available and generally acceptable as it is determined by the market and not the owners of the business.
When investors meet in the market as buyers and sellers of shares in listed companies, they form their own opinions about a company and how much they are willing to pay for a share.
The individual opinions of investors are then aggregated by the market into demand and supply for the shares. Using the well tested auction system, the stocks are traded at the best prices possible per single transaction.
This is the market valuation of a company by the investing public. The market cap of a company will therefore be changing every time the share price of the company changes upwards or downwards. The wealth of the individual investors will also be fluctuating as much.
Indeed market cap has now been adopted by companies as a measure of strength. It is therefore common to find companies advertising their market cap to demonstrate their strength in their respective sectors, economy or even globally.
Without listing their shares on a stock market or capital market, this would not be possible. It is therefore strategically beneficial for a company to list their shares on a stock exchange.
Investments are made for a purpose and that is to earn a return from the investment either through dividends or even capital gains when the shares are sold. Capital gain is only realized when one sells the shares.
The owners of a company will always have a reason to want to know the value of their business at a glance.
We say at a glance because this is the most readily available information.
However, the intrinsic value or “true” valuation of a company is determined using longer processes because sometime, a stock could be overvalued or undervalued by the market.
This perceived overvaluations or under-valuations are sometime reasons why stocks trade throughout as those who feel the stock is overvalued exit the investment by selling at those high prices, while those who feel the same stock is undervalued keep buying the shares.
Whenever major shareholders wish to exit from a company for any reason like mergers of business or exiting specific sectors or even in succession cases, the market capitalization will always provide a quick yardstick for indicating the level of investment involved.
When people inherit companies and may wish to cash in or take value on the investment, market capitalization is always the first pointer to the value of the company.
Changes in market capitalization, is also used by the owners of a business to monitor the performance of the management of a company.
Whenever a stock or share price of a company changes, some shareholders will always enquire to find out whether loss or gain is as a result of management’s performance or some other reasons beyond the control of the company’s management.
Depending on their assessment, they vote on the management by simply buying more shares of the same company in the stock market or vote against the management by simply selling the shares.
This stock market democracy happens continuously as trading goes on without any direct contact with the company.
However those investors who feel they can wait for an opportunity to intervene and question the management, would wait until the day of the Annual General Meeting to air their views.
Whenever listed companies seek capital expansion they go to the capital market to raise additional funds.
Listed companies will always have the advantage of raising capital easily and at much lower cost whenever their capitalization is high.
This is usually the case when the market prices are high implying that investors’ appetite for the shares of the company is high. The recent over-subscriptions in Uganda by the Uganda Clays company is a case in point in the region.
An over-subscription of a share issue or offer to the public occurs when the total amount of shares investors apply for in monetary terms exceed the amount of money the company is raising from the public.
The excess funds are usually returned to the investors by way of refunds. Market capitalization is additionally a significant factor for companies in businesses where the level of capital is regulated as a requirement to do business.
This applies to such businesses as banks, insurance companies and investment banks. Whenever these companies are required to raise additional capital to meet statutory capital requirements, they usually go to the capital market for the funds easily if they are readily listed on the stock market.
Unlisted companies do not have this window of flexibility to access funds directly from the capital market at advantageous cost. Indeed, listed companies especially in the financial sector, grow their capital consistently way ahead of unlisted companies.
Many listed banks and insurance companies on the Nairobi Stock Exchange have issued shares by way of rights issue in the recent months in response to increased capital requirements by the Central Bank of Kenya.
Kenya Commercial Bank is currently doing a rights issue to finance its regional expansion plans into the greater East African community market.
This should make financial institutions in Rwanda to take a strategic view of the capital market and list part of their companies on the Rwanda OTC market.
Robert Mathu is the Executive Director Capital Markets Advisory Council