Market Capitalization Meaning: Why Price Doesn’t Always Equal Value

Market cap, also known as market capitalization is the total market value of all of a company’s outstanding shares. It is also incorrectly known to some as what the company is really worth, or in other words the value of the business.

Keep reading to learn more about why it doesn’t always reflect a company’s actual value.

Market Capitalization Meaning

Market cap is also incorrectly known as what the company is really worth. The market cap formula is simply this:

The amount of dollars per share of a company x The total number of shares of that company.

Market capitalization is about the price of a company.

Find out if the companies that you invest in will make you money in the long run by learning the 4Ms to great investing.

Company Valuation with Market Capitalization

It is very important to understand that price is not necessarily the value of a company.

Price is what you pay for something, but value is what you get.

Let’s say you go out and buy a new Maserati, we’ll say that the value of the car is $100,000. If I paid $200,000 dollars for the car, it doesn’t mean that it’s worth $200,000. That’s just what I paid for the car. I massively overpaid for it.

Now, on the other hand, if I paid $50,000 for it, it also doesn’t mean that it’s worth $50,000. That’s just what I paid.

What’s really important to understand about stock investing in the public market is that market cap is just what we pay. What we need to know, this is how it relates to Rule #1 Investing, is what the company is worth. What is the company’s value?

The Price of a Company is Not Necessarily the Value

If we see that the company is worth more than the market cap has it priced at, then we know that we’re essentially buying a $10 bill, for 5 bucks.

The market cap is the big mistake that people and investors make in assuming that whatever the market is charging for a company, is what it’s worth.

A lot of people say that market cap is the value of the business. In fact, that is so commonly done that professors at some of the best universities in the country have made this mistake over and over again by assuming that what the market price is of a business is what the business is worth.

If you want to learn to properly value a company click here to learn the 4Ms to successful investing.

Conclusion

Warren Buffett says that, “Nothing is further from the truth.”

When you understand that about market capitalization and value, you’ve just taken your first major step to becoming a really great investor.

Remember, Warren Buffett started with $100 and turned it into $30 billion. That means that it isn’t about the money you have, it’s about the knowledge you have. It means there are no real barriers to you getting rich if you’re willing to work hard and learn. If you want to learn how Buffett and all of the best investors invest their money, start by learning the 4Ms for successful investing.

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About Phil Town – Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

  • Have you tried the Stock2Own site? It’s mostly based on Rule#1. It’s a great way to screen/evaluate potential Rule#1 candidates. I’ve been using it for years with great success.

  • P.

    Anyone know what happened to the calculators? They sure were useful, now they’re gone, or at least the paybacktime.com site is gone…

  • BBB

    Good blog on Market Price vs. Value. However, is there an exception? How about Drug Making companies. When I did my calculation, it seems their market price is almost always way above its value because it has a low EPS. However, this low EPS is largely due to its heavy investment in R&D. R&D is a bloodline for drug making companies as it’s REV making pipeline depends on its success. If all the R&D costs put in 5 or 10 years ago created a highly profitable drugs, then the new value of the companies 10 years from now where make the market price today (though way above its current calculated value) so very cheap. This is when I feel I cannot use historical PE to calculate my normal sticker price when it comes to drug making companies. The above thought is generated when I research stock NVO, a major druk making companies. Despite its overpriced Mkaret Price, it has been constistently growing since inception.

    I am still very new at this investment strategy, so I would like to hear comments from others about this. thanks.

  • Ross Hodgson

    Phil,

    I want to thank you for sharing your knowledge. I’m a huge fan of Warren, Charlie, and the like an used to invest exactly like them until I read Rule # 1 which taught me the importance of the technicals along with value. Your approach has helped me grow my portfolio withought having to experience the my portfolio declincing when the market gets irrational. My CAGR and average growth rate over the last 4 yrs is over 26% & 28%, respectively. Thank you.

  • Garrett

    Rulers,
    I’ve been reading books about the Global need for energy and who will be the big players in the energy industry. It’s a game of power, politics and outright warfare. Sure, there’s problems in Ukraine, but don’t let the headlines fool you – there’s very little here to do with freedom and democracy and all that other patriotic stuff – it’s a war about protecting and controlling energy markets.

    It’s currently estimated that there are about 2 Billion people in the world today without energy and another 2 Billion more that need it by 2050 – just 35 years from now. I don’t see the world’s demand for energy decreasing long-term. Charlie Munger says, “invert! always invert!” and I just can’t make a rational argument that the long-term outlook for energy is LESS.

    I suppose Warren Buffett agrees to some extent as he bought Exxon when oil was $100 a barrel.

    Nuclear energy – like it or not – is part of the world’s answer to meet this demand. There is one company that sell 16% of the world’s uranium needs and that’s Cameco (CCJ).

    Cameco was first mentioned by Phil after the big “Event” in Japan that caused Japan and later Germany to shut down their reactors. Fukushima brought the Uranium mining industry to its knees and Cameco went down with it.

    Many, myself included, thought that the industry would bounce back – but that has not been the case. It’s been in a four year decline ever since and even today according to CCJ’s 4th QTR earnings report they don’t expect much change in demand for 2015 but they should remain profitable thanks to existing contracts.

    The resent sell-off in commodities has exacerbated and contributed to CCJ’s 5 year low in its stock price – We know that price doesn’t equal value, but it’s a sure good place to start looking. This time “The Story” is different – at least at the moment the fear is NOT a global collapse in the financial markets but rather it’s a fear of slowing growth in the global economy.

    Since the Fukushima melt down, uranium has been in huge supply as Japan shut down reactors and Germany decided it was too dangerous for them too so they shutdown their reactors. In addition to that, US/Russia made an agreement to dispose of nuclear warhead missiles which has provided several million pounds of enriched uranium for use on the secondary markets. The small players in the mining industry closed shop because it simply wasn’t affordable to mine the stuff at such depressed prices.

    Meanwhile, CCJ has had the cash, the long-term contracts, and the brains to weather the storm and “manage during the good times to prepare for the bad times.” These last 4 years have been some of the hardest times.

    By the end of this year, most of those secondary supplies of Uranium are going to be gone. How do we know? Because everyone knows the number of nuclear reactors around the globe and how much Uranium it takes to keep them running. It’s a very simple to estimate.

    Over the next year, I don’t expect much to happen to the Uranium supply – but I’m starting to get ready.

    I’ll have more to write as I’m running out of time – Hopefully in a few days I can share more of what I’ve learned and why I’m bullish on Cameco over the next 30 years.

    To Your Wealth!
    Garrett

    • Fitz

      Hi everyone,

      I’ve been a long time stalker of this blog mainly because I was new and didn’t have enough of a knowledge base to contribute productively in the past. However when Garret brought up Cameco I figured I better chime in a bit considering I live a hour from their headquarters in Saskatoon and I’ve had a father and sister work for them. CCJ in my opinion and the opinion of their employees is really well run. They have gone through some very very tough times and management has been very efficient with their work force keeping spending under control. They also just got their Cigar Lake mine back up and running after it flooded costing them hundreds of millions in losses. Plus like Garret mentioned energy demand will not decline and in places like Japan they are restarting their reactors as nuclear energy is really their only viable option at this point…. Even despite their disaster at Fukushima. Their employees are treated like gold on site, their emphasis on safety is incredible and they have the rights to a mind blowing amount of uranium. I stuck a toe in the water and bought my first 100 shares at $14 and was hoping to try stock piling it on the way down as I believe it is set to go up in the next few years. I don’t have time to get into the numbers right now but I am a huge fan of their story and with them paying a small dividend I can use it as an extra way to reduce my basis. Anyway just thought I’d share a few thoughts on them.

      Fitz

  • AngelaW

    Howard Marks memo: The Lessons of Oil 12/18/2014
    http://www.oaktreecapital.com/MemoTree/The%20Lessons%20of%20Oil.pdf

    This is how he ends the memo.

    In the last 3 1/2 yrs, Oaktree’s mantra has been move forward but with caution. For the first time in that span, with some arrival of disarray and heightened risk aversion, events tell us that it is appropriate to drop some of our caution and substitue a degree of agressiveness.

  • Garrett

    Rulers,

    Speaking of Market Cap and Price vs Value in Phil’s headline, we’ve seen the market cap drop considerably on several companies in the oil industry. Is there VALUE here?

    As Rulers, we want to look at about 100 investments and find maybe 1 to invest. Saying “No”, “Pass”, “Too Hard to Value” or “Not in my area of knowledge” is a fantastic way to prevent from losing lots of money.

    The little companies selling oil offer us an opportunity to pass on some things pretty quickly by looking at who is hedged and who isn’t hedged against price changes in the cost of oil.

    Hedging is when a company locks in prices to help create some certainty in their sales. If a company locks 70% of their sales in a contract to sell their oil for $90 per barrel, then they’re hedged against some of the losses that could occur if the price of oil were to drop to say $50. Likewise, if oil rose to $200, they’d be kicking themselves in the butt because they could have sold their product for a lot more.

    Companies whose lifeblood depends on commodity prices, such as airlines, hedge all the time. It’s a balancing act and a form of insurance. Sometimes, they get lucky…sometimes unlucky…but bottom line a good CEO wants to know and plan what his costs are going to be so they can grow.

    Now that oil has tanked for the time being, we can learn the importance of making sure we have some insurance against rapidly falling oil prices. These guys are naked – they didn’t hedge and now their exposing themselves to huge and unnecessary risks.

    Unless you KNOW (and we don’t) when oil prices will rise, you’ve got to stay away from these companies because they weren’t hedged at all:
    Apache Corp. APA -29%
    Cimarex Energy XEC -18%
    Comstock Resources CRK -79%
    ConocoPhillips COP -20%
    Continental Resources CLR -70%
    Hess HES -24%
    Marathon Oil MRO -27%
    Murphy Oil MUR -23%
    Occidental Petroleum OXY -19%

    ConocoPhillips, Hess, and Occidental Petroleum have some assets that are NOT wholly dependent on commodity prices for profits. But the other guys …. I’d stay away.

    To Your Wealth!
    Garrett

    • Hanno

      Oil prices will rise between middle of february and beginning of march.
      This is my prediction. We have seen the bottom at $43. It will come back to rebound for a few years. It is said that oil will go up to $200!! Let’s see what will happen…

      Hanno

      • Garrett

        Hanno,

        If you only had $100,000 would you be willing to put all $100,000 on that guess? :)
        BP’s earnings report wasn’t so stellar. I think the only reason it went up is because they paid the DIV.

        To Your Wealth!
        Garrett

        • Erick Lindley

          totally agree Garrett. Right now people only care about the dividend and not abotu the position of the company.. For ex GM in rule one book… Stock tanking but still paying dividend not so good in my book.. just a thought

        • Mickey

          Garrett,
          I have posted before about ATW in the offshore drilling space. I can’t remember if it was you or Phil that disagreed with my assessment of the moat on the 4Ms, but I have been getting a mile deep in the company reading every SEC filing, seeking alpha article, the company website, and the presentation slides from every energy conference the company speaks at. During this time, I have been reducing basis by buying shares at lower prices, selling puts to open and selling covered calls when I have shares and just recently received the first dividend. I have reduced basis from over 40 to about 35. If you have done the home work on this company as I have, then I would accept your challenge to put all of that $100k amount into this one company based on the zombie value and the rest of the 4Ms. The argument is that they have a couple of new build UDW drill ships under construction without a contract on delivery. Mr. Market is treating their remaining jack up market just like the rest of the offshore space. But, by being a mile deep you would know the management (the CEO is a 25 year veteran of Transocean RIG) has this fully funded including the new dividend from the next two years of cash flows without borrowing additional money. In addition, the jack up fleet at ATW is not as old as RIG or others in the offshore space. ATW specifically has one of the youngest average age fleet in the space in this bifurcated rig market. If you don’t know what that means you are not a mile deep keep digging. While there is no easily identifiable moat in this company, most people will say anyone with $750M can go to an Asian shipbuilder order a ship and start leasing it to drill. The safety incident rate is one of the lowest in the industry, age of the fleet with the new high specification dual BOP rigs (which ATW has) and is frequently being required by their client post BP Macondo spill, and operation efficiency that ATW produces keeps their clients coming back with new contracts. Of all of the quarterly and annual reports that I have read including their competitors that ATW has the highest reported OE at 95-98%. I have yet to find anyone higher in the offshore space. Keep in mind OE is reduced as a company lets rigs sit idle until cold stacked or scrapped. Those three : safety incident which is a high meaning to me that I use in my own engineering and construction industry, average age of fleet with high spec rigs to meet new regulatory requirements, and OE are the key to meeting their client needs satisfaction and therefore the moat. I think this will help ATW not only survive but rise to the top once E&P start cutting back on their spending.

          I am long ATW and continue to drive down basis as the only investment in my 457 self directed account.

          • Jon

            Hi rulers,
            I have been watching the blog for awhile. Thank you guys for all your info. I recently purchased xom when it hit it’s repeated recent floor of 87-88. How do you guys value a company like xom when even in a recession it would not come close to 25 my calculated mos.
            I have also looked into atw and I like what I see for the most part but do you accept the climbing debt and poor cash flow when they have been investing in top of the line equipment heavily with the amount of decent contracts lined up? Also, what do you guys think about this drilling area with drilling slowing at this pace? It seems drillers stock will suffer further for a while even after oil starts rebounding creating better prices even though atw looks like a value now. I am a newbie and still learning. I appreciate your insight.
            I have owned facebook, polaris, and atk so far in my first year with moderate gains(but, outperformed my company 401k). Not sure about trading due to indicators turning too many times shortly after buying and missing out on large gains selling too early. I am leaning towards stockpiling methods with occasional trades.
            Thank you guys and gals

    • Shuki Sasson

      Hano & Garrett, don’t miss the big picture here.
      These oil prices and as a result the panic sell in OIL companies represent an amazing opportunity that will not come back soon.
      These are the times we value investors are waiting for!
      That is the time to pick up the best companies and load the track!
      There is no need for the tools but stockpiling buys.
      The companies I am invested in are CBI and NOV.
      If you want to follow what Phil Town is doing buy BP it is an excellent company too.
      Don’t let this unique opportunity pass!

      • Garrett

        Hi Shuki! I haven’t seen you post in over a year! I’m investing in commodities, oil companies, energy and watching GLD for a short-term bottom – I was glad to see it broke the 200MA.

        To Your Wealth!
        Garrett

      • Scott

        I’ve been digging into BP and have gone through the annual reports for the last 7 years and listened to the two most recent earnings calls. Doing the 4M analysis I have as competitive moat for BP its strong expertise in exploration, offshore drilling and extreme environments. Going forward that may be a good competitive strength as oil & gas are harder to find. I haven’t looked into the other majors yet i.e. Shell, Exxon and Chevron but I’d like to know what key differentiators they have from each other. Has anyone submitted a 4M analysis on any of these companies on the Rule #1 site that anyone knows of? This wouldn’t be the end of my research but would be nice for some extra context.

      • Doug

        Good points, Shuki. It will be extremely interesting to see if Buffett is buying, selling or holding CBI. Can’t wait to see his next quarterly report.

      • Mickey

        I agree that it is a good time to buy in the oil space. In addition to your NOV, I would add ATW as an offshore driller and Core Labs CLB.

        • Garrett

          Mickey,
          Thanks for taking the time to share a brief summary of your “inch wide, mile deep” research into ATW.
          I’m probably missing out on some opportunities because I’m sitting in too much cash.

          And good job reducing basis from low 40’s to $35.

          To Your Wealth!
          Garrett