Market Capitalisation
Anyone wishing to gamble in the
sharemarket must understand the concept of
market capitalisation, and having just talked about
penny dreadfuls, this is as good a place as any to
discuss it.
A share price of under 10c does
not necessarily make a company a penny dreadful, and
a price of $20 does not make a stock a blue chip.
The share price itself is not what is relevant, it
is the monetary value that the market is placing on
the company that the investor must be aware of. In
order to know this, you must know the number of shares
on issue.
This is a very simple concept.
Imagine company A has a share price of
5c. It has 500 million shares on issue, washing
around in the marketplace. By multiplying the number
of shares by the share price we get a figure of $25
million. This is what the market is valuing the company
at, or its 'market capitalisation'.
Company B meanwhile, has a share price of $1.50c,
thirty times more that of company A. However, it only
has 10 million shares on issue. By multiplying that
number by the share price we discover that its market
capitalisation is only $15 million, actually $10 million
less than that of company A.
So don't be fooled into thinking
that a relatively high share price necessarily
denotes a big company, or that the converse applies.
It is often the case, but by no means always. It is
worth remembering too, that a company with a higher
market capitalisation is not necessarily a better
company than one with a lower market cap. It is just
currently valued at more by the market. Some of the
small but well run companies of today will be the
giant corporations of tomorrow and history shows that
some of the poorly run behemoths of today will be
gone altogether within a decade or two.
It is important to know the market capitalisation
of any stock you are considering buying so that you
can assess whether you think the company is worth
the value being ascribed to it by the market. Even
if you are just looking to buy on your broker's recommendation,
it pays to know, as brokers can be wrong and you may
be shocked to learn the price tag that is being put
on the company you are buying into.
During the excesses of the nineties internet boom
at one point it was claimed by an unusually skeptical
analyst that even if the internet book company Amazon
was to sell every book on earth, the profits after
tax and overheads would not be enough to justify its
market capitalisation!
One very important thing to look for in working out
the market capitalisation of a stock you are interested
in is unlisted shares (and options that can
be converted to shares for a lot less than the prevailing
share price.) Unlisted shares are usually equal to
normal shares in every way but are privately owned,
often by employees or the company itself, and can't
be traded on the stock exchange. They do however represent
part of the value of the company and must be taken
into account in any valuation of the company.
NEXT ... Knowing
your place in the food chain
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