The Maple Investor

What Does A Company’s Market Cap Have To Do With Investing?

Author David Uram on March 11th, 2008

Why is a company’s market cap important?

A company’s market cap is what the market thinks the company is worth.

Most of us know that the market cap is found by taking the price of the stock and multiplying it by the shares outstanding. Let’s use Apple Inc (Also known as Apple computer) as an example.

At the close on March 10 2008, Apple Inc was priced at $119.69 a share . $119.69 is the cost to buy one share.

There are 878 million shares outstanding for Apple Inc. That means Apple has been broken up into 878 million pieces so you and I can purchase and own a part of it. f

When you multiply $119.69 X 878 million you get a value of 105 billion. That 105 billion is the company’s market cap. The market cap tells me that the stock market thinks that Apple Inc is worth 105 billion dollars.

I can agree or disagree with what the market is telling me. If I think Apple Inc is worth more than 105 billion then I would want to purchase some shares for an investment. If I think the market has overvalued Apple Inc at 105 billion then it would be a bad investment and I would not purchase the stock.

Question: “If I want to double my money within the next year is it possible”

If I wanted to double my money in Apple’s stock, Apple’s market cap would have to be valued at 210 billion and the price of the stock would be $239.38. Anything is possible, but is it likely? The higher the market cap of a stock the less likely it is to increase significantly just because companies can only grow to be so big.

Let’s take Exxon Mobile as an example which is the largest company in the world with a market cap of 450 billion.

Shares outstanding: 5,463,630,000 or 5.43 billion.

Price of stock: $82.46

$82.46 X 5.43 billion = 450 billion market cap

No other company in the world has a larger market cap than 450 billion so that’s the high end of the range for Market Caps.

If I expect to double my money in Exxon within the next year, Exxon would have to have a market cap of 900 billion and be priced at 164.92. The price doesn’t seem that high but a 900 billion market cap does! With a company like Exxon I would not expect a 100% within a year.

If I was in a stock market tournament and knew I had to at least double my money in short period of time in order to win, I would stay away from companies with a large market cap. It is easier for a company to double in price (and market cap)if it has 5 billion dollar market cap than a 100 billion dollar market cap. Not to say that company with the 5 billion dollar market cap is a better investment, it is just more likely that in a short period of time that the 5 billion dollar valuation doubling to 10 billion is more plausible than a 100 billion company doubling to a 200 billion dollar company in a short period.

Two things to take away from this article:

The price of a stock on its own doesn’t mean a whole lot other than the cost to buy one share. It is how you use the price to value a company (Market Cap, P/E) and other methods of valuation that makes the price useful.

The Market Cap is a valuation that signifies what the market thinks the company is worth. There are days when the market decides to offer a company at a discount to the intrinsic value of the company and other days when the market tries to take advantage of you and offer the company for more than its worth. It is up to you to decide what a good investment is and what is not. The market cap is just one piece of the puzzle to figuring out whether a stock at a certain price is a good investment.