“What is market cap, or market capitalisation?”
We hear this question a lot from people who are in the early stages of learning about investing. It’s a perfectly valid question, so we put it to members of our investing team to discuss.
RYAN: Scott, one of the terms that I see thrown around quite a bit is market capitalization or market cap. Can you give a bit of an explanation I guess as to what that actually is?
SCOTT: Yeah, sure. We’re used to seeing shares listed at a price per share, right? So Woolies might be $38 a share or Commonwealth Bank might be $80 a share. Now, that doesn’t mean Commonwealth Bank is twice the price of Woolworths, I mean, it does per share, but what’s missing is the number of shares outstanding. Now, let’s go back to my favourite pizza example, right? If I said to you, Ryan a slice of pizza? I’ll sell to you for 10 bucks, you say, well, hang on, that’s a lot for a slice of pizza. I’m going to say yeah, but how big’s the slice, and this is the key one here, right? So you see when you think about market cap market cap is the price of the whole pizza. One thing is say, okay, dollar a slice.? Do you want a pizza for a dollar a slice?
RYAN: I’d say yes please.
SCOTT: Unfortunately it’s that big. You happy with that? So that’s the difference the answer is market capitalization is the share price per share times the number of shares, in other words in our pizza example we are saying how much is the whole pizza, it’s not just $5 a slice, but it’s $20, because there are four slices, or it’s $2 and there’s 10 slices, market cap still $20, or the price of the pizza in this case is still $20. But the number of slices i.e. the number of shares, and the price per slice or per share, is where the rubber hits the road. And that really gives you a sense of the overall size of the company. You have two companies both worth $2 a share. If one’s got 10 shares, that’s a $20 company, if one’s got a million shares, that’s a $2 million company, same price per share a very, very different market capitalization, which tells you about the size of the company itself. Not just individual slice.
RYAN: So there’s no set amount of shares or set number of shares that any company any one company will have.
SCOTT: It’s kind of crazy, right? I mean, some countries have literally billions of shares because they’ve had they’ve raised so much money over time, they just keep issuing shares like confetti. Others have a reasonably small number of shares. It absolutely it’s irrelevant. This is what’s really hard for people to understand if you look at a list of share prices $2, $5, $10, $20, people are tempted to kind of look at those in in kind of relative terms a $20 company is 10 times as expensive as a $2 company, or what’s more worrying for us, people say it’s like 10 cents a share, it doesn’t have to go that much to be 20 cents. It’s only going up 10 cents! versus the $10 company that’s going up $10 to $20. That’s actually exactly the same thing. They’re both got to double in size to get the return you’re looking for. So it’s really, really important not just to think about price per share, but the value of the overall company. In other words, its market cap.
RYAN: Okay, so really the market cap, we know what the market cap represents, what market cap would you generally look for?
SCOTT: You’ve come out with great questions. So the other interesting point, it doesn’t matter all that much, but it is worth thinking about what would have to happen, to get the growth you want out of an investment you might make. I just said a $2 company and a $20 company can be the same size. That’s true. But a $2 million company and a $2 billion company have to do a lot differently, right? Woolies is going to really struggle to double its size from here because it’s already got a thousand plus supermarkets it is already a really big business. How does it double from here? So looking at it’s absolute size gives you that sense. if you got a $20 million company, heaps riskier, but also does have more potential to grow because it simply doesn’t You don’t need as much additional growth, to go from 20 million to 40 million in market cap, in market size versus a business like Woolies that’s already in the multi you know, tens of billions of dollars and that’s the key difference here. So be careful of companies that are too small, they seem attractive, but they’re probably super, super risky. The ones that are too big can be great solid investments but probably aren’t going to give you the sorts of returns you might be after. If you’re trying to beat the market.
RYAN: That makes perfect sense. Thanks a lot, Scott.
SCOTT: Thanks, Ryan.