Investing Series: What does market capitalization (market cap) really mean?

This is a part of the Investing Series.

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All it means is how big the company is on the stock market.

Class dismissed!

NO REALLY, WHAT DOES IT MEAN?

Seriously!

How you calculate market capitalization is by doing the following:

Market Capitalization =

# of company shares issued x price of the share today

So let’s take Lululemon (LULU) (who has been going through some tough times with their crappy Chinese suppliers):

# of Lululemon shares issued: 112.52M or 112,520,000

 

Price of Lululemon shares: $64.71 (see above)

112,520,000 x $64.71 = $7,281,169,200 or $7.28B

Of course you could have just looked for that value labeled Mkt cap, but where’s the fun in that?

 

HOW MARKET CAP IS USED

Market capitalization is simply used to see how big a company is in comparison to another.

The more shares you have issued with a higher stock price, the bigger you are.

The less shares you have issued with a lower stock price, the smaller you are.

This only matters if you want to know who is influencing the stock market with their stock prices.

Taking a look at some big players in the market, you can see that their market cap is way bigger than other companies, and you will notice that these companies tend to have a Beta that is closer to 1.

• Read: What does beta mean?

 

In comparison, little LULU at 7.28B is not that big compared to these companies, but then again, size is all relative, is it not? 🙂

BUT WHY DO I EVEN CARE HOW BIG THEY ARE?

You care about size because for one thing, you care about risk (the smaller they are, the more likely they are to fold).

Think of it like investing in a beluga whale versus a fish like a sardine, and betting on how long one will survive or last over the other.

On the one hand, the beluga is going to swim faster, be able to go the distance and survive for a longer period of time (not going to be caught to be eaten, as they’re HUGE!!!).

A sardine or a smaller company on the other hand, may end up in a beluga’s stomach, or in the fishing nets to be eaten.

Which one would you rather bet your money on?

It’s the same idea — the bigger the company is, and the more they have invested on the stock market, the more likely they are to be stable companies (having grown over time), and to have a lot invested (pun intended) in making shareholders (you and me!) happy.

If you pick a small no-name company in the middle of some state, and their market cap doesn’t even reach a million, you’re betting on them with a risk that is much higher than let’s say plowing your money into General Electric or Exxon Mobil.

That said, you may end up investing in a very tenacious little sardine who ends up beating all the odds and surviving a nice long life, and one day, blossoming into a big beluga whale……

O_o

Err… you know what I mean.

It’s not really possible, but you get the drift.

SUMMARY

• Market capitalization refers to how big a company is on the stock market
• You multiply shares outstanding by the stock price to get market cap
• It shows you how big the company is compared to others around it
• You care about their size because it determines their risk