A company's worth—orits total market value—is called its market capitalization, or market cap. A company's market cap at any given time can be determined by multiplying its stock price by the number of shares outstanding.
Therefore, any significant change in a stock price results in an equal percentage change in the company's market cap. This is one of the reasons why investors are so concerned with stock prices. A $0.10 drop in a stock price results in a $100,000 loss on paper for a shareholder with one million shares.
Key Takeaways
- A company's market capitalization—also called its market cap—is a straightforward measure of the company's market value.
- Market cap is calculated by taking the current share price and multiplying it by the number of shares outstanding.
- For example, a company with 50 million shares and a stock price of $100 per share would have a market cap of $5 billion.
- Stocks are often classified according to the company's respective market value, Big caps are companies that have a large market value while small caps have a small market value.
How Is Share Price Determined?
Broadly speaking, prices in the stock market are driven bysupply and demand. This makes the stock market similar to other economic markets. When a stock share is sold, a buyer and seller exchange money for share ownership. The price for which the stock is purchased becomes the new market price. When another share is sold, this price becomes the newest market price.
There are various techniques and formulas that can be used to predict the future price of a company's shares. Calleddividend discount models (DDMs), they are based on the concept that a stock's current price equals the sum total of all its futuredividend payments (whendiscountedback to their present value). By determining a company's share by the sum total of its expected future dividends, dividend discount models use the theory of the time value of money(TVM).
A company's market capitalization is calculated by multiplying its share price by the number of shares outstanding:
Market Capitalization = share price x number of shares outstanding
A company's market cap is first established in an initial public offering (IPO). In preparing for this process, a company pays a third party (typically an investment bank)to determine the value of a company, and recommend how many shares to offer to the public and at what price. For example, a company whose value is estimated at $100 million may want to issue 10 million shares at $10 per share.
Once a company goes public and its shares start trading on a stock exchange, its share price is determined by supply and demand in the market. If there is a high demand for its shares, the price will increase. If the company's future growth potential looks dubious, sellersof the stockcan drive down its price.
For example, suppose that Microsoft (MSFT) is trading for $71.41 on Sept. 8, 2022, and has 7.7 billion shares outstanding. Assume also that the company is valued at $71.41 x 7.7 billion = $550 billion. Meanwhile, Meta (META), formerly Facebook, has a $162.06 stock price and 2.69 billion shares outstanding (market cap = $435.5 billion). As of this date, Meta is worth less than Microsoft.
Misconceptions About Market Capitalization
Although it is often used to describe acompany (e.g., large cap vs. small cap), market cap does not measure the equity value of a company. Only a thorough analysis of a company'sfundamentals can do that.
Market capitalization is an inadequate way to value a company because its market price is not necessarily a reflection of how much a piece of the business is worth. Shares are often over- or undervalued by the market.
Market price shows only how much the market is willing to pay for its shares, not how much it is actually worth.
Even though market cap measures the cost of buying all of a company's shares, it does not determine the amount the company would cost to acquire in a merger transaction.
While market cap is often used synonymously with a company's market value, market cap really refers only to the market value of a company's equity, not its market value overall, which would include the value of its debt or assets.
FAQs
A company's market cap at any given time can be determined by multiplying its stock price by the number of shares outstanding. Therefore, any significant change in a stock price results in an equal percentage change in the company's market cap.
How is a company's stock price determined? ›
What determines stock prices? The price of a stock is largely determined by supply and demand. If demand is high, the price tends to go up, and if supply is high, the price tends to go down.
How is the market cap of a stock determined? ›
To calculate market cap, you take the total number of a company's shares outstanding and multiply that figure by the company's current stock price. For example, if a company has 5 million shares outstanding and its current stock price is $20, it has a market capitalization of $100 million.
How does the stock market determine the value of a company? ›
The Bottom Line
An asset's market value is determined by the price that buyers are willing to pay for that asset, and the price that sellers are willing to accept for it. For publicly traded companies, the market value usually refers to the market cap.
How is the market value of a stock determined in Quizlet? ›
The market value of a stock is determined by: multiplying the number of shares outstanding by the market price of the stock. the number of investors willing to buy a stock versus the number of investors willing to sell.
How is market price determined? ›
Price is dependent on the interaction between demand and supply components of a market. Demand and supply represent the willingness of consumers and producers to engage in buying and selling. An exchange of a product takes place when buyers and sellers can agree upon a price.
How do you determine the value of a stock? ›
The most common way to value a stock is to compute the company's price-to-earnings (P/E) ratio. The P/E ratio equals the company's stock price divided by its most recently reported earnings per share (EPS). A low P/E ratio implies that an investor buying the stock is receiving an attractive amount of value.
What determines market cap rate? ›
A market cap rate is determined by evaluating the financial data of similar properties which have recently sold in a specific market. The Cap Rate calculation incorporates a property's selling price, gross rents, non rental income, vacancy amount and operating expenses thus providing a more reliable estimate of value.
What is the relationship between market cap and stock price? ›
A company's market cap at any given time can be determined by multiplying its stock price by the number of shares outstanding. Therefore, any significant change in a stock price results in an equal percentage change in the company's market cap.
How to calculate price based on market cap? ›
Understanding Market Capitalization
Market cap is calculated by multiplying a company's outstanding shares by the current market price of one share. Since a company has a given number of outstanding shares, multiplying X with the per-share price represents the total dollar value of the company.
Under the assets approach method, the fair market value (FMV) is calculated by computing the adjusted assets and liabilities held by a company. It takes into account intangible assets, off-balance sheet assets, and unrecorded liabilities.
How do you find a company's stock value? ›
Price-to-earnings ratio (P/E): Calculated by dividing the current price of a stock by its EPS, the P/E ratio is a commonly quoted measure of stock value. In a nutshell, P/E tells you how much investors are paying for a dollar of a company's earnings.
How does a company determine its value? ›
1. Book value of your business (asset value) Take your total assets and subtract your total liabilities. This approach makes it easy to trace to the valuation because it's coming directly from your accounting/record keeping.
How is stock price determined? ›
Stock prices are determined by the relationship between buyers and sellers, and dictated by supply and demand. Buyers “bid” by announcing how much they'll pay, and sellers “ask” by stating what they'll accept. When they agree on an amount, it becomes the new stock price.
How do you determine market value of shares? ›
Market Value Per Share Formula
The market value per share, or equity value per share, is equal to the market capitalization divided by the total number of diluted shares outstanding. In short, the market value per share reflects the stock price of a company at present.
What factors help determine the market value of stock? ›
4 key factors for valuing stocks
- Financial ratios. Price-to-earnings (P/E) ratio: This figure compares the price of a stock to the company's earnings per share (EPS). ...
- Industries. ...
- Corporate fundamentals. ...
- Macroeconomic factors.
Stock prices are set by what's known as the secondary market, which is the technical term for investors trading shares among themselves. This is opposed to the primary market, when a company sells shares of stock directly to investors. A stock's price is set by supply and demand in a secondary market.
What two factors determine the price of a company's stock? ›
Stock prices are driven by a variety of factors, but ultimately the price at any given moment is due to the supply and demand at that point in time in the market. Fundamental factors drive stock prices based on a company's earnings and profitability from producing and selling goods and services.
Do companies set their own stock price? ›
The price is set based on valuation and demand from institutional investors. After the initial offering, the stock starts to trade on secondary markets -- that is, stock exchanges such as the New York Stock Exchange (NYSE) or the Nasdaq. This is where we get into the market being a voting machine.
How is price calculated in stock market? ›
In the stock market, the price is determined by a price discovery mechanism. It happens when the buyers and sellers agree on a price level. Stock prices depend on the bid and ask price of the stock. A “bid” is an offer to buy a certain number of shares for a specific price.
