Money Rehab with Nicole Lapin - WTF is Market Capitalization?

Episode Date: October 25, 2021

Nicole got a question (from a Money Rehabber you’ll recognize) about “market cap.” Him and his friends have been using market cap data to make decisions around their investments, but then they came to the realization… they don’t actually know what it means, or whether that should be a metric they use. Today, Nicole steps in to help! Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. Today we have a very special question from a very special listener and very special producer,

our own Mike Coscarelli. Mike, take it away. Hi, Nicole. This is Mike from Brooklyn. First time Mike, take it away. Hi, Nicole. This is Mike from Brooklyn. First time caller, long time listener. Anyway, so my friends and I have a group chat about investing called The Real Wall Street Bets, where we discuss red hot stock tips and investment strategies. Last week, my friend Adam pitched us to buy shares of a stock. My friend Matt didn't like that stock because the price was too high, but also because the market cap was too. We all agreed. But then two messages later, Adam admitted that he didn't know how market cap was calculated, which was great because as it turns out, the rest of us didn't know either,

even though we were using it as a metric. So my question is, what is market cap? And does it actually matter when making a decision to invest in a stock? We need your help. The fellows in the Real Wall Street Bets, we're all counting on you. So here's the deal. Market cap is a cute little nickname for market capitalization. It's a measurement to help us understand to what extent a company is a big deal. First, I'm going to tell you how market cap is calculated, and then we're going to get into what it actually means and how you should consider market cap when investing. All you need to know right this very second is the big picture, which is that

market cap is a number that represents the value of a company specifically from an investing perspective. Before we can calculate market cap, we need to unpack one last jargony term, shares outstanding. Here's the dictionary definition. Shares outstanding is essentially the number of shares issued by a company. You can see why you would want to know the details on a company's shares outstanding because that can really affect your payout as an investor. If you invest in a company and you know that this company has $1 million to split between all their shares outstanding, it makes a really big difference whether you're splitting a $1 million pot between two people or like a million people. Shares outstanding will tell you if you are a big sunfish in a kiddie pole or a teeny guppy in the Atlantic Ocean. And we use the number of shares outstanding to calculate market cap. To find the market cap, you take the number of shares

outstanding and multiply that by the share price. So let's say I own a company and I have a share price of $20 and have 1 million shares outstanding. To get my company's market cap, I would multiply the $20 share price by a million shares outstanding. And ta-da, we get a market cap of $20 million. In the world of Wall Street, market cap is often used as a metric to classify companies. In the last example, I had calculated a market cap of $20 million for myself. But in the stock market, that's not a lot of moolah. A company with a market cap of under $300 million is called a micro cap or a penny stock. Can you imagine calling anyone with 300 mil micro?

Ouch. Okay, so let's work our way up the scale a little bit more. Above micro is a small cap company. A small cap company is a company with a market cap between 300300 million and $2 billion. And then after that, we have mid-cap companies. Those are companies with a market cap value between $2 billion and $10 billion. And then we have the large cap status that is reserved for companies with market caps between $10 billion and $200 billion, with a B. If you can believe it, there is also a mega-cap categorization, which is just everything more than $200 billion. And that's for the really giant companies like Apple, that by the way, currently has a market cap of over $2 trillion. Conventional wisdom is that risk decreases as the cap gets larger. In other words, a larger cap company like Apple is too big to fail. On the flip side,

it's generally suggested that smaller cap companies are riskier but have the most room for growth. Sometimes these things are true, but not always. To those who say large cap companies are too big to fail, I would point you to Enron. When Enron went under, its market cap was $65 billion. Enron is a perfect example of the issue with market cap. Market cap doesn't tell the entire story about the company. That's my issue with people making big investment decisions based on only a handful of statistics

that show up on investing apps or Yahoo Finance. You want to be making informed investment decisions based on what the company is going to do in the future. You can't make that informed decision if you're only looking at a snapshot of a company at that one moment in time. You also need to look at its history. So use the time that you would have spent calculating market cap to take a closer look at other indicators that the value of the company is growing, like a consistent rise in share price year over year, or an announcement that the company is putting more money into research and development, let's say for a new cutting edge product or service.

For today's tip, you can take straight to the bank. Start integrating these dictionary terms into your daily life so that you get more comfortable with the concepts. You'll make smarter investing decisions when you can decode the headlines. But at the very least, you'll also be able to impress your friends with some smart investing small talk. Like so-and-so company is a micro cap company now, but I expect its market cap to jump in the next five years. Hey, you'll impress the heck out of them with that kind of stock talk. Itor, and Will Pearson. Our mascots are Penny and Mimsy. Huge thanks to OG Money Rehab team, Michelle Lanz for her development work,

Catherine Law for her production and writing magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.