Market capitalization, or market cap, is one way to measure the size of a company and can be used to compare investments. This week’s Perspective discusses how understanding a company's market cap can help investors evaluate investments. We’ll start with definitions and then give a couple of examples.

Definitions

The term market cap is really the same as market value for our purpose. Here is some easy math; market cap is calculated by multiplying the total number of outstanding shares by the current stock price.

For Example

Take Apple, maker of computers and iPhones. Its market cap is around $2.2 trillion making it one of the largest companies in the world. The stock is trading around $143 per share at last check (keep in mind this number fluctuates throughout the trading day). Total outstanding shares of Apple are around 16 billion. That billion with a B. Now simply multiply 16 billion shares by the stock’s price, and we get our market cap. Roughly $2.2 trillion.

Now let’s consider Avis Budget Group. You may have seen Avis if you’ve ever rented a car at the airport. They are a relatively smaller company. The Avis market cap is under $8 billion, with around 41 million shares outstanding. You could fit 275 Avis into one Apple in terms of market cap.

One company of note regarding share price is Warren Buffet's Berkshire Hathaway. Their series A stock trades at around $470,000 for just one share. Sounds expensive right. Again, we look to market cap to round out our understanding. Berkshires’ market cap is around $683 billion. Larger than Avis but still smaller than Apple.

Additionally, inclusion in the S&P 500 index is heavily weighted by market cap. The index, which is made up of the top 500 public companies in the U.S., is often used to describe market performance broadly.   

Understanding Market Cap

Next we’ll show why stock price alone doesn’t tell us much about a company’s value. Going back to Apple and Avis. Apple stock is $143 and Avis stock is $190. Again, these numbers are just for example. By price alone, one might think that Apple is cheap. It’s $47 dollars less per share than Avis, after all. This is where market cap, that is, knowing the total number of shares along with the stock price tells us how much of the pie we would actually own.

Other Factors

Market capitalization is not the only factor in determining if a stock is a good investment. Other factors such as the company's growth prospects, financial health, and competitive advantages should also be taken into consideration.

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