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Why Market Cap Is More Important Than Stock Price

Updated on September 20, 2018
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I have a passion for investments, personal finance and a variety of other subjects and I love to write about them.

One of the better ways to evaluate a company that you may be considering investing in is to determine its market capitalization. This is contrary to what many do which is to judge a company’s value by its stock price. The misnomer here is that people tend to believe that a high stock price means that the company is a better investment than a company with a lower stock price. This is not always the case. Once you discover how to calculate a company’s market capitalization you can more effectively and accurately guage whether you want to buy shares in that company or not.

What Is Market Capitalization?

The market capitalization of a company is simply the number of shares it has outstanding multiplied by its current stock price. Youc can also perform the calculation on previous time periods for a view into the company’s market cap history. Once you have done these calculations you begin to get a clearer picture of the health and strength of any given company. Let’s have a look:

Say you have a firm that has shares valued at $60.00 per share and there are 40,000,000 shares available to buyers. These are the shares outstanding. You simply multiply $60.00 by the 40,000,000 shares out there.

Here is an example of what I am describing:

Stock Price = $60.00

Number of Shares = 40,000,000

Market Capitalization = $60.00 * 40,000,000 = $2,400,000,000

Let’s consider another example:

Stock Price = $50.00

Number of Shares = 60,000,000

Market Capitalization = $50.00 * 60,000,000 = $3,000,000,000

As you can see upon first glance the higher stock price of the first company seems to make the first company’s stock the most attractive buy. But the second calculation shows clearly that the second company’s total valuation makes it a more valuable company in actuality and thus the better investment. Of course there are several other factors that should be considered when considering investing in a company’s shares. This is only a simple illustration of a calculation that is commonly used to value companies for the purposes of investing.

What Can The Market Cap Tell You?

A company’s stock price can be a misleading variable when trying to determine a company’s real value. It is an arbitrary figure that fluctuates from day to day depending on market trends and does little to help evaluate a firm’s soundness or value. It isn’t really indicative of the company’s total value and so should be considered less important than the total market cap. When looking at the various market caps of companies you’re considering investing in you will quickly notice size tiers among the various firms. Some will have super large market caps and some will have market caps that aren’t so large. Generally firms are sized up using the following scale:

Small Caps = Under $1 Billion

Mid Caps = Between $1 Billion and $10 Billion

Large Caps = Over $10 Billion and larger

The key takeaway is to understand the market cap value of one company in comparison to others in the same size class. For instance one company may seem like a great value according to the value of its stock price, but when compared to other companies with a larger market cap it isn’t so good a buy.

Knowing this information you help can better assess a firm’s valuation in relation to other companies of similar type and size. The best advice I can give is to consult a financial professional when considering investing in stocks or other investment vehicles. A financial professional can lend support and can answer any questions you may have regarding the market caps of firm’s and other useful information.

© 2018 Jeff Morales

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