What Are the Advantages of Using a Market Capitalization Model?

by Walter Johnson ; Updated July 27, 2017

The market capitalization method, or MCM, is the easiest and most popular form of determining the market worth of a business. It measures the size of a business by multiplying the price per share by the number of shares in existence. There is a slight variant of the MCM that is becoming more popular, and that is the “free float” version of MCM. This model multiplies the price per share by the number of shares readily available for trading. This method is the one with the most advantages.

Simplicity

MCM has one great advantage: it is simple and direct. Anyone can do it. It is also the most honest. Even if the share prices are distorted because of debt or media-created demand, it reflects the value of the stock as the market sees it. This is all most investors care about.

Size

MCM deals with a firm's size as seen by the market. If you are an investor who only wants relatively safe and stable investments, then the MCM is the only model you will use. This is because what is defined as stable is generally limited to the larger-cap stocks such as Wal-Mart. The quickest way to identify the larger, more stable firms is by using MCM because it deals only in sheer bulk.

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Availability

Some investors argue that the free float version of MCM is important because it improves on the basic advantages of MCM in general. If the great advantage of MCM is its honest reporting of a firm's worth based on the total amount of issued stock, the free float method is even better because it only deals with what is important to investors: the price of stocks available now.

Demand

The free float mechanism of the MCM reflects market trends better than the MCM by itself. Part of the reason for this is that it reduces the influence of any stocks that are not tradable, and hence not relevant to the market. If MCM shows a firm the way the market sees it, then MCM-FF is a more accurate indicator of the market trends of the firm. If the shares are inactive, then they tell us nothing about any additional value of the stock deriving from demand, or high trading volume. Demand is a part of firm value and should be reflected. Demand is about investor confidence. The free float method more accurately reflects the importance of demand by dealing only with those shares that can, in fact, be demanded.

References

About the Author

Walter Johnson has more than 20 years experience as a professional writer. After serving in the United Stated Marine Corps for several years, he received his doctorate in history from the University of Nebraska. Focused on economic topics, Johnson reads Russian and has published in journals such as “The Salisbury Review,” "The Constantian" and “The Social Justice Review."

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