Market Capitalization

The market capitalization or market cap calculation computes the current fair market value (FMV) of the corporations common shares outstanding. Studies have shown that small cap stocks tend to outperform large cap stocks.

The purpose of financial analysis is threefold:

• to determine the growth potential of the firm,
• to determine the level of risk within the firm, and
• to determine the financial flexibility of the firm

The limitations of ratio analysis

• Large multinational conglomerates with many different business segments can be difficult to analyze. The difficulty is compounded by the investor's inability to identify comparable competitors against which to measure the conglomerate.
• Qualitative factors such as: economic and political considerations, management ability, marketing ability, and the human resources of the firm are not measured in the traditional financial statements.
• Corporate management can manipulate the financial statements by making accounting choices which are available to them and still remain within the acceptable standards required by the generally accepted accounting principles (GAAP) in order to put the best face on information contained within the financial statements.
• There is always a time delay between the end of an accounting reporting period and the actual publication of the firm's quarterly or annual financial statements. The delay can be several months.
• Management choices regarding the reporting of financial activities will vary from company to company, making comparisons difficult for an investor. For example, 2 identical corporations in the same industry may choose different depreciation rates for their equipment, or they may choose different accounting techniques for reporting inventory.
• Ratios do not necessarily disclose the quality of their components. For example, a high current ratio might mean that a company has high accounts receivable or inventories and not cash.
• Financial statements are based on historic costs and therefore may be misleading during periods of inflation.