Wasn't it only yesterday that you read about Reliance Industries' market capitalisation touching the Rs 2 lakh crore mark?

And a few days back it was Asea Brown Boveri (ABB) in the news for its proposed stock split.

While those accustomed to the stock market lingo can easily understand what these terms mean a few of my young friends were completely at large when they heard about the market capitalisation and stock splits.

I was also equally confused the first time I heard these terms. But then I must thank my friend who helped me understand these terms with ease.

This is what he told me about market capitalisation and stock splits.

Market capitalisation

It is the money value of a company's shares put together. In short, it is referred to as market cap.

Mathematically, it is the market price of a company's share multiplied by the number of shares on a particular day.

Stock price of a company at the end of the day * Number of shares = Market capitalisation.

There are two types of market caps that investors must take note of: Full market cap and free float market cap.

Free float market cap

Any company during its IPO will not sell all its shares to the investors. Suppose, it has total outstanding of 100 shares then it may only sell 10 shares (10 per cent) during its IPO.

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These 10 shares are freely floating and are available for trade when the stock lists on either the Bombay Stock Exchange or National Stock Exchange. These shares then can be bought and sold by people like you and me.

If on the first day of listing the stock price of this company closes at Rs 20 then we can say that the free float market cap is Rs 200.

Stock price of a company at the end of the day (Rs 20) * Number of free floating shares (10) = Free float market cap (Rs 200).

Full market cap

The shares owned by the companies' promoters or owners might not be available for sale in the stock markets. The owners can sell them later or may not sell at all.

In the above example the company did not sell 90 shares for some reasons. If we count these shares then the total number of outstanding shares of this company is 100.

To calculate total market cap one must take the total number of outstanding shares into consideration. The total market cap of the above company will be Rs 2,000.

Stock price of a company at the end of the day (Rs 20) * Total number of outstanding shares (1000) = Full market cap (Rs 2,000).

Remember, the free float market cap will always be less than full market cap.

Apart from these, you may have also come across terms like a large cap stock, a mid cap stock or a small cap stock. These three categories are defined depending on their market caps.

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While there is no fixed definition for these three categories market participants like mutual funds, brokers, foreign institutional investors or retail investors like you and me have their own assumptions.

Normally, any company having a market cap of more than Rs 2,500 crore is considered as large cap stocks. However, there are certain companies having market cap of more than Rs 9,000 crore considered as mid cap companies.

While mid cap companies are those having their market cap between Rs 250 crore and Rs 2,500 crore, small cap companies are those with market cap of less than Rs 250 crore.

However, opinion is very sharply divided over what constitutes a large cap, a mid cap and a small cap stock. 

Stock split

A process by which a company divides the face value (the nominal value of a share) of its share is called stock split.

It is usually done in a ratio. On February 16, ABB announced a stock split in the ratio of 5:1. What it means is one share of face value Rs 10 will be split into five shares of face value Rs 2.

The overall effect for an investor holding the stock remains the same pre-split and post split.

The value of one share of face value Rs 10 (pre-split) with an investor is the same as five shares of face value Rs 2 (post split).

For instance, if a company has a market price of Rs 500 (face value Rs 10) and you have 10 shares of this company, then the total value of shares owned by you will be Rs 5,000.

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Now if this company announces a stock split in the ratio 5:1 then each share you own of this company will be split into five shares. Also, the face value of these shares post-split will be Rs 2.

But the total value of your shares will remain the same.

Because on the day this split comes into effect, the value of each share will become Rs 100 (Rs 500/5) and the number of shares with you will be 50 (because of the 5:1 stock split).

As each share will be split into five, 10 shares will equal 50.

Normally, companies announce stock split when the value of their stock reaches three digits or four digits. That is, they go beyond the reach of retail investors.

An ABB at Rs 4,000 may seem dearer (pre-split) than an ABB at Rs 800 (post 5:1 stock split).

A stock costing Rs 5,000 (pre-split) will cost Rs 1,000 (for 5:1 stock split) and Rs 500 (for 10:1) stock split.

As an investor you may find owning a Rs 500 share or Rs 1,000 share much cheaper than a Rs 5,000 stock. However, as explained above these values are only notional because the total value of your shares remains the same.

Other thing about stock splits is it increases the number of shares available for buying and selling. If a company has 100 number (pre-split) of free floating shares, the number of shares post-split will become 500 (5:1 stock split) or 1,000 (10:1) stock split.

In case of a 10:1 stock split a share of face value Rs 10 will get converted to a share of face value Rs one.