How To: Market Cap

Market Cap is one of the most visible pieces of financial information when searching for a stock. It simply measures the market value of the total value of all shares outstanding.

The formula is:

Market Cap = Current Share Price * Total Number of Shares Outstanding

Many people think of market cap as a measure of the size of the business. I'd consider that to be only partially true. A company's market cap represents the total free cash flow available to shareholders of over a business's lifetime discounted to present value.

Because the overwhelming majority of a company's free cash flow is based in the future, and the future of the business is not guaranteed, there is a certain element of speculation baked into a company's market cap. Depending on where the company is in its lifecycle its some companies value may be based much more on future projections than others.

In the short term a company's stock price is simply based off the supply/demand for that stock in a given time period. If there are more sellers than buyers, the stock goes down and vice versa. It would be difficult for me to solely base how large a company is based off the supply demand for its stock.

In some cases, stocks may swing wildly up and down in a short period of time. Even established companies like Apple could move 20% up or down in a single week. It is unlikely any information for a company that scale should change the value of the business by 20% in a single week. But it happens, and it creates opportunity.

Market cap also does not account for the capital structure of a business. In short businesses raise money by selling equity and issuing debt to fund their operations. A companies enterprise value better captures a company's total asset base and is perhaps a better shorthand for how large the company is. Debt isn't all bad however, as a company issuing debt does so with the intention to buy assets that will earn a rate of return higher than the cost of that debt.

Source: The Acquirers Multiple

Even if market cap does not tell you much about the operating business, it still and essential metric because it will be your benchmark to compare how much market thinks something is worth vs what you, the investor, thinks it is worth.