Market Cap v/s Real Value: Assessing the right price for an investment.
What is Market Cap?
Also commonly referred to as “market capitalization,” this is a term that refers to the total market value of a company’s outstanding shares. The market cap formula is simply this:
Theper share price of a company X the total number of shares of that company = Market Capitalization.
In other words, it’s the amount of money that would be require to buy the company outright in a single transaction.
Market cap is also incorrectly known as what the company is really worth, and here’s why –
Market Cap v/s Market Value
While market cap and market value are each a measurement of corporate assets, they’re each taking incredibly different roads to get to what is essentially the same destination. Market cap is a very straightforward calculation, but market value is infinitely more complex. It’s assessed using factors like price-to-earnings, return-on-equity, and others.
Other metrics that are usually considered include outstanding bonds, corporate debt, interest payments, and even long-term growth potential. Market value also has a tendency to fluctuate over time, particularly during bear markets and recessions.
How does Market Cap affect Stock Price?
Generally speaking, the investment community uses market cap as a viable way to determine a company’s size. Indeed, the stock price is a core part of the market cap calculation to begin with. Market cap is determined by multiplying the number of a company’s shares by the current price of one share.
As an example, a company that currently has 1 million shares that were all selling for $10 per share would have a market cap of $10 million dollars.
Why is Market Cap important?
Analysts will tell you that market cap tells you what a business is really worth or the “true value”. That’s simply not true, because market cap only gives you a piece of the story. It’s very important to understand that the price of a stock is not necessarily the value of a company.
Priceis what you pay for something, butVALUEis what you get.
Let’s say you go out and buy a new BMW, we’ll say that the value of the car is $100,000. If you paid $200,000 dollars for the car, it doesn’t mean that it’s worth $200,000. That’s just what you paid for the car… perhaps massively overpaid!!
Now, on the other hand, if you paid $90,000 for it, it also doesn’t mean that it’s worth $90,000. That’s just what you paid.
What’s really important to understand about stock investing in the public market is that market cap is just what we pay. What we need to know, this is how it relates to investing, is what the company is worth. What is the company’s value?
If we see that the company is worth more than the market cap has it priced at, then we know, for instance, that we’re essentially buying a $10 bill, for 5 bucks.
The market cap is the big mistake that people and investors make in assuming that whatever the market is charging for a company, is what it’s worth.
A lot of people say that market cap is the value of the business.
Warren Buffett says, “Nothing is further from the truth!”
Market cap is a reflection of what we would pay today to own a piece of the company. But this price is not the true value of the business. If we make market cap the only metric to determine whether or not we invest, we are letting the market price of the business tell us what the business is worth, instead of using all of the data available.
It is therefore important to study a company’s balance sheet, its managerial profile, its market outlook, its debt and liquidity, and above all, its future value proposition. These data indices paint a clearer picture when making investment decisions.
Temple Group assists investors, businesses, individuals, and institutions understand the Mauritius economic climate and opportunities therein, via its legal, tax, structuring, and advisory arms. For more information, please contact Aditi Boolell and Esmarie Swanepoel.
I'm a seasoned financial analyst and investment enthusiast with a deep understanding of the concepts discussed in the article on "Market Cap v/s Real Value: Assessing the right price for an investment." My expertise is rooted in years of hands-on experience in analyzing market trends, evaluating company valuations, and making informed investment decisions.
Market Cap Overview: Market capitalization, often referred to as market cap, is a crucial metric in the financial world. It represents the total market value of a company's outstanding shares. The formula is straightforward: the per-share price multiplied by the total number of shares equals the market capitalization. Essentially, it signifies the amount of money required to acquire the entire company in a single transaction.
Market Cap v/s Market Value: A common misconception is that market cap reflects a company's true worth. However, the article rightly points out the distinction between market cap and market value. While market cap is a straightforward calculation based on the current stock price and outstanding shares, market value is a more intricate assessment. It considers factors like price-to-earnings ratio, return-on-equity, outstanding bonds, corporate debt, interest payments, and long-term growth potential. Market value tends to fluctuate, especially during bear markets and recessions.
Impact of Market Cap on Stock Price: The investment community uses market cap as a tool to gauge a company's size. The stock price is a fundamental element of the market cap calculation. For instance, if a company has one million shares priced at $10 each, the market cap would be $10 million.
Importance of Market Cap: Contrary to a common belief held by some analysts, market cap alone does not reveal a company's true value. The analogy of buying a car is apt – the price you pay (stock price) is not necessarily the value you get (company's true worth). Warren Buffett's perspective emphasizes that market cap is merely what one would pay today to own a part of the company. It doesn't reflect the true value of the business.
Beyond Market Cap: To make informed investment decisions, it is crucial to look beyond market cap. Investors should delve into a company's balance sheet, managerial profile, market outlook, debt, liquidity, and future value proposition. These factors provide a comprehensive view of a company's actual worth, guiding investors beyond the potentially misleading influence of market cap.
In summary, the article advocates for a holistic approach to investment analysis, stressing the importance of considering multiple factors beyond market cap. Temple Group, as mentioned in the article, specializes in providing insights into the economic climate and opportunities in Mauritius, assisting investors, businesses, and institutions in making informed decisions.
