The sixth lesson in the BUX homeschooling series answers one simple question: what’s a company really worth? And the answer yields some interesting insights. Let’s take a look.
What is it worth?
In many ways, the stock market is no different to any village market. The principal is the same: a place where buyers and sellers come together to trade. And the most common question you hear at a village market is: “how much does it cost?”
People also want to know that on the stock market. Suppose, for example, you want to take over Shell. How much does that cost?
Well, people have found a simple way to value companies: market capitalization. You’ll also hear it called ‘market value’ or the short-hand version, ‘market cap’.
Simple, yet surprising
You can easily calculate the market capitalization of a listed company. You take the number of freely tradeable shares and multiply it by the current price per share. Here’s the sum written out:
Number of freely tradeable shares x the current price = market capitalization
Not too complicated, right? But there is more to it than this quick calculation.
Defining freely tradable shares
First you need to know what we mean by ‘freely tradeable shares,’ also known as the ‘free float’.
It’s important to understand that not all shares of a company are freely available. Heineken is a well-known example of this. Only 40% of Heineken shares are freely tradeable. The rest? Well, a whopping 25% are owned by the Netherlands’ richest person, Mrs. Heineken herself, so they’re not considered freely tradeable.
Market cap changes daily
The price per share and the number of tradeable shares changes constantly, so a company’s market cap fluctuates.
But now you know that a company with 20 million freely tradeable shares, which cost £100 each, has a market capitalization of £2 billion.
And a company whose shares cost £1,000, but with only 10,000 shares freely tradeable, has a market capitalization of ‘only’ £10 million.
Fun fact: the FTSE 100 consists of the 100 largest UK companies. The index is compiled on the basis of market capitalization. That’s why some companies are relegated if their market cap falls below others in the index.
Mapping the market capitalization of various companies can paint some pretty interesting pictures* and comparisons. You can see here that video company Zoom is now worth way more than four major airline companies combined. The amounts displayed are in billions of dollars.
And here’s Tesla, in comparison to a couple of other car manufacturers.
*Amounts rounded. Data from May 19, 2020.
All views, opinions or analysis expressed in articles are that of the author and do not represent the views of BUX. Neither BUX nor the author provide financial advice and these articles should not be construed as such.