Why Per-Share Price Is Not as Important as Market Cap
Market cap is the true measure of a company's value
There's a common misconception that per-share price is as important as the market cap when it comes to investing in a stock. This is especially the case among new investors but it isn't correct. Market cap should be your key consideration when you're evaluating a stock because it tells you the value of a company.
The Per-Share Price Fallacy
Why is a stock that cost $50 less than another stock priced at $10?
This question highlights a point that often trips up beginning investors. The per-share price of a stock is thought to convey some sense of value relative to other stocks, but nothing could be farther from the truth.
In fact, the per-share price is virtually meaningless to investors doing fundamental analyses except for its use in some isolated calculations. If you follow the technical analysis route to stock selection, it’s a different story, but let’s stick with the fundamental analysis for now.
We're not concerned with per-share price because it's always changing and because each company has a different number of outstanding shares. This being the case, it doesn’t give us a clue as to the value of the company. For that figure, we need the market capitalization or market cap number.
Determining the Market Cap
The market cap is found 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: $50
Outstanding shares: 50 million
Market cap: $50 x 50,000,000 = $2.5 billion
To prove our opening sentence, look at this second example:
Stock price: $10
Outstanding shares: 300 million
Market cap: $10 x 300,000,000 = $3 billion
This is how you should look at these two companies for evaluation purposes. Their per-share prices tell you nothing by themselves.
What You Can Learn From Market Cap
So what does market cap tell you? First, it gives you a starting point for evaluation. When you're looking at a stock, it should always be in a particular context. For example, how does the company compare to others of a similar size in the same industry? The market generally classifies stocks into three categories:
- Small Cap: under $1 billion
- Mid Cap: $1 billion to $10 billion
- Large Cap: $10 billion plus
Some analysts use different numbers and others add micro caps and mega caps. You can talk to financial experts about their particular preferences, but the most important point is that you understand the value of comparing companies of similar size during your evaluation. You'll also use market cap in your screens when looking for a certain size company to balance your portfolio.
The Bottom Line
Don’t get hung up on the per-share price of a stock when you're making your evaluation. It really doesn’t tell you much. Focus instead on the market cap to get a picture of the company’s value in the marketplace.
NOTE: Always consult with a financial advisor for the most up-to-date advice and answers to any specific questions you might have. The information contained in this article is not intended as investment advice and it is not a substitute for investment advice.