Market Capitalization (market cap) and Total Return are good indicators to predict value that occurs in the stock market. However, it is important to recognize total return is used as metric to evaluate stock portfolio’s performance and its value. Market capitalization shows the value of a company, but it cannot or should not be used as metric to evaluate performance of an investor’s portfolio. For any investor, it is important for them to recognize, total return is more important than an increased market cap.
Market cap is outstanding shares multiplied by stock price. For example, if Company A has 1 million stocks outstanding and the share price is $10, the market cap would be calculated with the following formula:
Outstanding Shares x Share Price 1,000,000 x 10 = $10,000,000
Therefore, Company A’s market capitalization would be $10 million. Market capitalization also reflects the value of a company and its market capitalization used to categorize company as Large Cap, Mid Cap, or Small Cap. A Large-Cap company has market capitalization over $10 billion; Mid-Cap company is any company that has market capitalization within a range of $2-10 billion, and Small Cap $250 million to $2 billion. There is not a consensus of capitalization range; therefore, it will differ in how range is stated.
Total Return is the return of an investment that consist of dividends along with increase or decrease of the stock. Total return can be calculated few ways; however, for simplicity, the total return formula is as followed:
Total Return =End of Year Investment Value – Beginning of the Year Investment Value +Dividends/ Beginning of the Year Value of the Investment
For example, If Investors had portfolio that was worth $4,000 at beginning year, at the end of year the value is $5,000, and dividend income of $400, the Total Return can be found by following calculation:
End of Year Investment Value= 5,000
Beginning of Year Investment Value= $4,000
Dividends = 400
(5,000 – 4000) + 400/2000 = 1400/4000
Total Return = 35 percent
An increase in market capitalization does not provide investors enough information about their stock portfolio. It does not account for any dividends that are earned. Since market capitalization can increase by the companies issuing new stock, an increase in market cap does not always translate to an increase in value of a stock portfolio.
Market cap does not account for position taken in stock. For example, if a portfolio sells stocks short, it means the investor wants the the share price to decline. However, if the the stock prices increases while the stock is being sold short, the stock portfolio would lose money.
In some cases, an increased market capitalization does not cause the return of a stock portfolio to increase. Market capitalization is only used to show value of an actual company and not a portfolio. Total return is a Swiss pocketknife compared to an increased market capitalization.
Total return provides more-detailed information to investors regarding the performance of their stock portfolios than the use of market capitalization as a metric. Total return will account for gains and losses that occur with a stock portfolio. It will account for any position taken in a stock. Total return will allow investors to view the value of their investment at the beginning of the year and this cannot be done with the use of market capitalization.
Total return is important, because it shows the actual value and growth of stock. It accounts for performance and dividends of all stocks in an investor’s portfolio, and unlike market cap, it is not easily manipulated to show an increase value. Therefore, total return is a far better than increase in market capitalization.