Riddle me this: Why would a stock that costs $100 per share be worth less than another stock that’s trading at $20 a share?
The answer to that question, which often trips up new investors, lies in the difference between a company’s per-share stock price and its market capitalization (or “market cap”), which is the current total price of every share of stock the company has issued.
Let’s start with our bottom line: Market cap is the primary consideration for investors when looking at stocks. That’s because the market cap of a company tells you about its value.
Now, here’s where some folks have a misperception. Many investors believe that the per-share price of a stock tells the whole story of value relative to other stocks. Not so. In fact, it’s quite the opposite; the per-share price has almost no meaning to investors looking at the basics of businesses’ financials. For investors doing a technical analysis in the process of stock selection, the per-share price does hold value, but this is an exception and not the rule.
So, my advice for folks seeking to understand the true value of a business, direct your attention to the company’s market cap.
How do you find this value? Essentially, with pencil, paper, and some simple math. Just take the per-share price of a stock, and then multiply this number by the total number of outstanding shares.
Here’s an example. Say a stock is priced at $100 per share. The number of outstanding shares is 50 million. To get the market cap for this company, you multiply $100 times 50 million, for a grand total of $5.0 billion.
Consider a stock with a per-share price of $20. There are 300 million outstanding shares in this company. The market cap, in this case, would be $6.0 billion.
As you can see, our two examples go to show that the per-share price, at best, tells us little about how a company is faring. At worst, it can be misleading to new investors.
Now let’s talk about what market cap does say about a company. It provides investors with a beginning point for evaluation. You want to know how the company you’re interested in stacks up against other companies of similar size in the same industry. To this end, you can make informed comparisons using its market cap.
The most important point to glean from our review is the value in investors making comparisons of companies of similar size during their evaluation. The market cap will come up again later when you’re looking for certain company sizes (small, mid, or large cap) to balance your portfolio.
So, remember to glance at the per-share price if you like, but direct your focus to a company’s market cap to get a better picture of the company’s value in the marketplace.
