Six Rules For Investing In Stock Market
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How Stock Market Capitalization Measures The True Value Of A Company
Why is a stock that costs N50 considered cheaper than another stock priced at N10? This question opens a point that often confuses beginner investors: the per-share price of a stock is thought to covey some sense of value relative to other stocks. Nothing could be farther from the truth.
In fact except for its use in some calculations, the per-share price is virtually meaningless to investors doing fundamental analysis. If you follow the technical analysis route to stock selection, it’s a different story, but for now let’s stick with fundamental analysis.
The reason we aren’t concerned with per-share price is that it is always changing and, since each company has a different number of outstanding shares, it doesn’t give us a clue to the value of the company. Gone are those days when Nigerian Breweries in the brewery subsector was the most capitalized company listed on the floor of the Nigeria Stock Exchange. In the market now the banks are in a tussle over which of them will emerge the most capitalized bank because of the measure of their value.
For that number, we need the market capitalization or market cap number. Find below current StockPicks’ 40 most capitalized stocks.
The market capitalization is calculated by multiplying the per share price by the total number of outstanding shares. This number gives you the total value of the company or stated another way, what it would cost to buy the whole company on the open market.
Here’s an example.
Stock price = N50
Outstanding shares: 50 million units
Market Cap:N50 x 50,000,000 = 2.5billion.
To prove my opening statement, look at this second example:
Stock price : N10
Outstanding shares: 300 million units
Market Cap: N10 x 300,000,000 = N3billion
This is how you should look at these two companies for evaluation purposes. Their per share prices tell you nothing by themselves.
What does market capitalization tell you? First, it gives you a starting place for evaluation. When reviewing a stock, it should always be in a context like ….. how does the company compare to others of similar size in the same industry? The market generally classifies stocks into three categories:
Small cap under N1billion units
Mid cap N1- N10 billion units
Large cap N10 billion units Plus
Some analysts use different numbers and others add micro caps and meg caps, however, the important point is to understand the value of comparing companies of similar size during your evaluation.
You will also use market cap in your screens when looking for a certain size company to balance your portfolio.
As I conclude this week, don’t get hung up on the per-share price of a stock when making your evaluation. It really doesn’t tell you much. Focus instead on the market cap to get the picture of a company’s value in the market place.
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2 Users Response In " How Stock Market Capitalization Measures The True Value Of A Company "
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey
For a short seller it is okay to brag at such things but when you look at the current market situation in the US, you can tell that those with stiff handle on overrated prices are telling jokes by the end of Novermber. The parameter you used is commendable to a certain degree, especially when the bull is rife. However you cannot necessarily believe that all things price at high is necessarily sustainable. Well I can say this cos am recently unemployed by the one of many companies doing so well, but my investment is necessarily elsewhere sinec I saw the risk of cheap valuation. Let me further discourage this attitudeby further citing two examples as at November 21. Ak steel, a favorite of many going in middle of last year at a price of &70 per share, went beyond moonlighting of &1 per share. They layed off 4 thousand workers and shut down two plants at thier base in Dayton Ohio. From an investor position, this is real kill since big haulers are certain that the problem is with the Euro and the supply side people are baying for will have to wait for another 25 years. The Euro, given the massive contraction in Europe will crash and dismember and you can expect the money to aggregate to necessary normal levels. The question is…who will benefit? General Motors is another point in that GM is selling for less than a dollar as at 19th of November because people sustained the departure of thier money from GM corporate bonds to holding cash. GM at some point in the past sold for 200 a pop. If you understood what I just explained in terms of Euro you can tell that GM will either restructure or re-acquire momentum especailly with the appointment of Hilary as Sec/of State. You can spy a net work of possibility that US open market policy will assume conservative by January. These futures are selling way below normal and you can look beyond the pittance of one dollar per share. If you doubt me, ask Warren Buffet where his nose is at the moment/Stocks with recent poor records. Expensive yes, but very highly recommended. Even Nigeria as a function group/stell complex etc can do wonders with these stocks now.
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